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Fund Flows Paint a Contradictory Picture

Investors seem to be avoiding risk in most areas except emerging markets.

Kevin McDevitt, 08/24/2010

Flows into U.S. open-end funds increased slightly in July to $14.1 billion versus $13.5 billion in June. But this small change understated the acceleration in this year's underlying themes. Almost universally, outflows picked up in equity and balanced categories; and inflows rose for bond, alternative, and commodity funds.

Nearly $12.4 billion exited U.S. equity funds last month, despite a strong rebound in share prices. While the average domestic large-blend fund is still down 6.8% overall during the past three months, the category gained 6.8% in July. International-stock funds saw less severe outflows of $565 million, but strong flows to emerging markets offset redemptions from foreign large-blend funds.

Interest in bonds continued to pick up steam, with taxable-bond funds adding $22.3 billion in July. This is a 26.7% gain over June's rate. Results for municipal-bond funds were even more dramatic, with inflows nearly doubling month over month to $3.9 billion.

These trends suggest that risk aversion continues to be the dominant sentiment, but that makes the continued flows out of relatively conservative balanced funds all the more confounding. The moderate-allocation category took the brunt of this development with nearly $2.1 billion in outflows.

On the other hand, alternative and commodity funds continued their surge. Alternative funds took in about $1.7 billion, with the long-short and bear-market categories benefiting most. The bear-market category has amassed $3.2 billion over the past year, despite losses of 24.9% during that time.

(View the related graphic here.)

Embracing Emerging Markets
In looking at the international-stock flows, there's less evidence of this risk aversion, at least as it's traditionally defined. Most of the recent inflows here have targeted diversified emerging-markets equity funds rather than the broader foreign-stock categories (foreign large value, blend, and growth). In July, diversified emerging-markets stock funds took in almost $2 billion, while the three major foreign-stock categories saw combined outflows of $624 million.

This isn't a recent trend, either. During the past 12 months, diversified emerging-markets equity funds have absorbed nearly $20 billion versus $25 billion for diversified foreign-stock offerings. While foreign-stock funds have the edge during that period, it's actually a fairly small margin, considering that those three foreign categories combined have nearly 4 times the assets of the diversified emerging-markets category.

What isn't clear is how much of this move to emerging markets is a strategic shift or just performance-chasing by investors. After all, emerging-markets stock funds have smoked most competitors over the last decade. The typical fund has delivered 10.6% annualized over the last 10 years versus a loss of 1.3% for the S&P 500 Index.

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