Wed, 18 Apr 2012
A desire for more control over asset allocation, disappointment with performance, and a sharp focus on fees may be behind the shift toward passive equity funds.
Christine Benz: I'm Christine Benz for Morningstar.
Stocks surged in the first quarter of 2012, but investors were buying bond funds instead.
Joining me to discuss the latest trends in mutual fund inflows and outflows is Kevin McDevitt; he is editorial director with Morningstar.
Kevin, thank you so much for joining me.
Kevin McDevitt: Christine, thanks for having me.
Benz: Kevin, we have just been through a quarter in which investors have shown a strong preference for bond investments over stock funds; let's talk about some of the categories within the bond fund universe that have been the biggest beneficiaries of new investor cash.
McDevitt: ... It's really been a combination of some actively managed funds and some passively managed funds, but the runaway winner has really been DoubleLine Total Return, which we have been discussing for quite some time, Jeffrey Gundlach's fund. And it has taken in about $6.4 billion so far for the year-to-date, and $15.4 billion over the past 12 months. And that reflects ... what's been happening in the category as well. The intermediate-term category has been by far the most popular over the past year-to-date and also over the last 12 months.
The runner-up there would be high-yield bond funds. They have also been quite popular on both the ETF side and on the open-end side, taking in about $21.5 billion year to date. To put that in perspective, [inflows have been] about $42 billion for intermediate-term bond funds.
So, those have both been the runaway winners on the fixed-income side and overall.
Benz: So, it seems like investors are kind of betting on opposite sides of the coin there, right? Because the intermediate-term funds are generally pretty high quality whereas high yield, it seems like [investors] would be banking on an economic recovery, which could actually crunch some of the high-quality funds if inflation and interest rates tick up?
McDevitt: That's been one of the dichotomies or just one of the riddles of the last three years. High-yield bond funds got crushed terribly during the credit crisis. And yet investors seemed to have really warmed to them and have been much more willing to dive back into high yield than perhaps some other risk-oriented categories, especially on the equity side. But I think certainly with rates at zero and with a need for income--with an aging population, more investors looking for income--in a sense, you can see the argument and the interest in going to high-yield bond funds.
Benz: And that DoubleLine fund for sure has one of the higher yields in the intermediate-term bond category, too.
McDevitt: It does, and its returns have been stellar so far. So, again, you can see, on the face of it, you can see the attraction.
Benz: So, Kevin, let's switch over to equity funds and discuss what's been going on there. One thing that you all noted in the most recent report where you discussed fund flows was that ... large-cap actively managed equity funds had their 11th straight quarter of outflows. What do you think is driving investors out of actively managed products, and to some extent, into passively managed products or out of the asset class altogether?
McDevitt: Well, it's good to make a few--as you did there--to make a few distinctions. It's not necessarily that there has been as much of a move out of equity funds as some might imagine. There has been certainly a shift toward fixed income over the last three years, and that period you talk about, over the last 12 quarters, really since the market bottomed in March 2009.
You've really had a tremendous rally in the equity market, but you haven't really seen that much money going back into equities. It has been more fixed income. But the biggest loser in all this, as you mentioned, has been actively managed equity funds.
If you go back three years, the actively managed equity funds had about 73% market share among all U.S. stock funds; that has fallen from 73% to about 67% today, and about a third of the market share has gone to passively managed funds, both open-end index funds and also ETFs.
... In terms of why that's happening: I think there has been a real disillusionment with actively managed funds, and I think part of that certainly is performance related, and part of that, I think, is also a push--among advisers at least--to have more control over asset allocation and perhaps wanting to have more control over how much they are paying out in fees. And I think actively managed funds are still quite expensive in many cases relative to passive funds, and ETFs certainly. So there is also a cost component to this, too.
Benz: So I'm sure that fund companies who do field large lineups of active products are really probably pretty terrified about this trend. Do you hear from them in terms of what they think about this trend toward passively managed products, and how that's affecting how they think about their lineups?
McDevitt: You know, it's a great question. As you might imagine, it's something they don't really want to talk about very much, especially if you're looking at a firm like, say, American Funds, which has, again, been kind of a poster child for active outflows. I think, from ... the standpoint of someone like American, they're really sticking to their guns, and I don't see them really changing their business model away from active management anytime soon.
You see other shops kind of hedging their bets and ... offering more passively managed products both on the open-end side and then offering ETFs, too. But it seems like to me in many ways the actively managed funds and the active management community have not really responded that well. I think they're still looking for the proper response to the move into passively managed products, and really they have not yet met that challenge.
Benz: Kevin, I would like to now talk about what you've been seeing in the international realm. It looks like international funds, in contrast with domestic equity funds, have been seeing somewhat more robust flows, but have the emerging-markets funds been the only ones gathering assets? What's going on there.
McDevitt: That's certainly true on the open-end side. On the open-end side, inflows are entirely dominated by emerging-market funds. You see maybe some tepid flows into some of the more core-oriented foreign large-cap funds, but really not very much. It's much more so going into emerging-market funds.
When you broaden the picture and look at ETFs, you see some flows going into other categories, again, more the core foreign large-cap stock categories, but still you've seen the greatest interest going into emerging-market funds. After intermediate-term bond funds and high-yield bond funds, the third most popular category across ETFs and open-end funds is the emerging-market category. So yeah, it's somewhat similar, but again a bit more balanced on the ETF side.
Benz: So, that's not quite the head-scratcher it was when we saw the same pattern late last year when performance was terrible, investors were continuing to add to emerging markets. This year's first quarter at least emerging markets were quite good in terms of performance?
McDevitt: They were quite strong, but still, that said, what's interesting is returns ... have been better ... over the last quarter, or if you want to go back to the last six months, ever since the market kind of bottomed at the end of the third quarter, domestic equity funds have actually done a bit better--if you're talking about small caps in particular (small caps have done better than the large-cap domestic equity funds), but those have been the top performers so far over the last six months.
Benz: Kevin, it's always great to talk to you, hear your thoughts on the intersection between investor behavior and fund company asset flows. So, thank you so much we appreciate hearing from you.
McDevitt: Thank you, Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.