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Fear Trumps Greed in June Fund Flows

Investors lose their taste for U.S. stocks and high-yield bonds.

Kevin McDevitt, CFA, 07/14/2011

Estimated long-term fund flows turned negative in June for the first time since December 2010. May's $22.6 billion in inflows became nearly $4.5 billion in June outflows. But investors did not take refuge in money market funds, which saw more than $41 billion in outflows, most of which targeted taxable funds. These were the greatest money market outflows since nearly $75 billion left those offerings in January. Investors broadly cut back on risk in June and U.S. stock funds took the brunt of their risk aversion. Domestic-equity funds surrendered about $18 billion in net redemptions, making it the worst month for U.S. stock offerings since the peak of the credit crisis in October 2008.

International stock funds fared better, but still had $1.3 billion in outflows. Flows into taxable-bond funds dropped by nearly $9 billion to $11.9 billion, but this drop owed mostly to high-yield outflows. Alternatively, municipal-bond flows continued to turn the corner, registering nearly $1 billion in inflows. Similarly, despite falling another 4.5% on average, commodities funds reversed last month's outflows with about $500 million in new contributions.

U.S. Stock Funds: Pre-Emptive Outflows
After trending down for four months, U.S. stock flows fell off the table in June. To put this in perspective, June's $18 billion in outflows easily eclipsed the $10.8 billion that fled after the flash crash in May 2010. In June, most domestic stock funds fell just 1.50% to 2.25% on average. Granted, a slow U.S. recovery along with the crisis in peripheral Europe continue to cause consternation, but these concerns have been lingering for more than 12 months. Perhaps investors are worried about a potential U.S. government default, but money actually went into government-bond funds in June (more on this below).

Whatever the catalyst, outflows touched every major equity category. Although large-cap funds once again took their own special beating (forfeiting a combined $10.3 billion), small- and mid-cap funds also got spanked. Small-growth funds, for instance, suffered their worst outflows ($1.4 billion) since March 2003.

Interestingly, the gap between active and passive flows reached its greatest level since March 2009. In June, a nearly $20 billion difference separated active and passive U.S. stock fund flows. Actively managed U.S. stock funds accounted for all of June's outflows, while passively managed funds actually had inflows of nearly $1.1 billion. It's hard not to notice, too, that some of the funds taking the worst lumps are a who's-who of active management. Several prominent funds, including American Funds Growth Fund of America AGTHX, Fidelity Magellan FMAGX, and Davis NY Venture NYVTX, saw their worst monthly outflows in years. Fairholme FAIRX watched another $1 billion walk out the door, bringing its four-month total outflows to $3.5 billion.

High-Yield Bond Funds: Pre-Emptive Outflows, Part 2
Investors soured on credit risk in June, too. Again, inflows into high-yield and bank-loan funds had been slowing in recent months, but investors hit the brakes hard in June. The nearly $6.3 billion in June high-yield outflows represents a 10-year high, narrowly beating May 2010's $6.2 billion in outflows. But at least that had been the same month as the flash crash. In June, high-yield bond funds fell a pedestrian 1.1%. That's peanuts compared with the average 15.5% high-yield bond fund loss during the worst of the credit crisis in October 2008. Even after that horrific month investors yanked just $1.9 billion from high-yield funds.

What gives? It's possible that investors have become more concerned about deteriorating credit quality globally given the sovereign issues in peripheral Europe and the United States. Disappointing GDP growth in the U.S. may have been a more proximate cause, as high-yield bonds tend to be economically sensitive. Yet, investors may still be more concerned about interest-rate risk than credit risk given that bank-loan funds still enjoyed positive flows. However, even though the category collected $1.3 billion in new money, this is a far cry from the more than $5.5 billion absorbed this past January. Plus, June marked the fifth consecutive monthly decline in bank-loan flows.

On the other hand, traditionally more-conservative bond categories continued to rebound in popularity. Intermediate-term bond funds led the way with $4.7 billion in inflows. Even government bond funds have returned to favor. The three government categories took in about $1.2 billion combined in June. Intermediate-government offerings, which had been largely shunned since last fall, welcomed about $700 million in positive flows, their first in eight months. This episode shows that, even with the threat of U.S. government default looming, when shock waves reverberate through global markets, many investors still turn to Treasuries for protection.

Persistent flows into world-bond and emerging-markets bond funds would seem to contradict this flight to safety. But the flows into world-bond funds continue to be dominated by just one fund: Templeton Global Bond TPINX. That fund claimed about $2 billion of the $2.9 billion that went to world-bond offerings. Guess which world-bond fund came in second? Sibling Templeton Global Total Return TGTRX collected about $230 million in inflows, which also happens to be run by Michael Hasenstab.

As for emerging-markets bond funds, investors likely continue to see these as ways to diversify out of the dollar without getting infected by the eurozone crisis. Plus, these funds still offer relatively attractive yields. Nearly half the $2.2 billion that flowed into this category went to PIMCO's two local-currency funds: PIMCO Emerging Local Bond PELAX and PIMCO Developing Local Markets PLMAX.

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