Mon, 13 Jan 2014
Passive equity funds, noncore bonds, alternatives, and many of the fund shops that sell them fared well last year, while core bonds, commodities, and gold suffered.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com.
Investors returned to equity funds in droves in 2013. Joining me to discuss the industry's biggest winners and losers in the fund flow sweepstakes is Michael Rawson. He's a fund analyst with Morningstar.
Mike, thank you for being here.
Michael Rawson: Thanks for having me, Christine.
Benz: When you look at fund flows for 2013, the big headline is that equity funds were the big winners. When you drill into equity funds, where do you see the flows going? Where were investors buying in 2013?
Rawson: For several years, we'd seen massive inflows into bond funds, and people generally avoiding equities. That reversed last year. Some people called it a great rotation. It certainly happened. Investors put money into equities, particularly international equities. U.S. equities got some good flows. There was some talk that maybe active managers would finally have their year. It didn't quite turn out that way. Active managers had mild outflows--not nearly as bad as they had been in past years. So there's been some improvement, but it's still passive flows driving flows into U.S. equities. Sector funds also had strong flows.
Interestingly, internationally, it was the developed markets, such as Europe and Japan, that were driving flows. In the past, it's been the emerging markets; investors wanted to put new money into emerging markets.
Benz: You touched on the fact that investors have been preferring passive products. And this is true not just within the traditional mutual fund space, but also in the exchange-traded space, obviously, where most of the products are indexed.
Rawson: Absolutely. ETFs had another good year last year as well.
Benz: You also note that some fund shops have been particularly big beneficiaries of this preference for passive products. Let's talk about a couple of those.
Rawson: Vanguard, of course, comes to mind. They had over $100 billion of inflows out of $400 billion roughly. Basically, one out of every four dollars going into funds went to a Vanguard fund, which is truly amazing. So they were able to increase market share almost a full percentage point over their competition. iShares, which is owned by BlackRock, also has a big ETF lineup.
And we saw some firms that aren't in the ETF industry start to make inroads, or start to try to enter that market. Fidelity launched their sector funds. Fidelity for a long time had sat on the sidelines. And we're hearing some talk that JPMorgan is going to aggressively embrace ETFs. JPMorgan is kind of interesting in that they've had success through the proprietary bank channel, selling through their financial advisors, where most other banks have not. So it will be interesting to see if JPMorgan can apply that success to ETFs.
Benz: Vanguard, in terms of the specific funds that investors are buying, you mentioned that the index products have done very well. But some of the target-date funds that buy those index funds have also had a really good run in terms of garnering new flows.
Rawson: The three funds with the strongest flows last year, in 2013, were all Vanguard index funds that sit in their target retirement series. So, Vanguard Total Stock Market and Vanguard Total International Bond Market, which is actually a new fund--but because it was a new fund that they wanted to put in their target-date series, they reallocated from their existing bond funds into this international bond fund, and it got $18 billion of assets basically overnight. So these funds benefit from the constant dollars that savers are putting into the [target-date] funds, and that's really the way it should be.
Benz: One firm that is not passively focused, Dimensional Fund Advisors, nonetheless does have sort of an emphasis on index-like products. Let's talk about the strong flows into some of DFA's funds.
Rawson: DFA also had a very good year. It's interesting, when you look at what asset classes or sectors they did well in, there was no one sector individually, but it happened to be all three: U.S. equities, international equities, and bonds. A lot of people think of them as being just a small-value shop, and that's all they offer, but actually they have a strong international lineup, particularly emerging markets, and a strong bond lineup. They were able to increase assets in their bond funds, whereas a lot of fund providers had outflows.
So, Dimensional Fund Advisors had a good year, and like you said, they sit on that fence between passive and active. Maybe they use some active approaches, but generally their portfolios are very diversified and low-cost.
Benz: Among the winners for 2013, in your view, are investors who have benefited from some of the price wars we've seen among providers of some of these indexed products. You note that there have been some cost wars, and that has been a net positive for investors?
Rawson: When you look at the assets in mutual funds, the assets are all with the low-cost funds. There are very few assets in high-cost funds. So, I think investors are benefiting. I mentioned that Fidelity is entering ETF market. They entered with very low price points; that's going to benefit investors. Another firm that comes to mind is Charles Schwab. It's a smaller asset manager, at least on the long-term mutual fund side, but their funds are all very low-cost, and they were able to make a substantial increase in market share. So we're seeing the companies that have low costs really gain assets.
Benz: Let's switch over to bond funds, Mike. It wasn't as good a year for bond funds, but among those categories that investors were buying were what you call noncore bond funds. What sorts of funds are those?
Rawson: If we break the bond universe into three segments: We've got core bond funds, very short-term bond funds, and then noncore or more exotic bond funds. People were avoiding the interest-rate risk that they have in their core bond funds. Generally, the only thing [core bond funds] really give you is interest-rate risk and diversification from credit or the stock market. Well investors didn't want to take any interest-rate risk because there is a perception that interest rates are going to rise, as they have, so they exited core bond funds. Particularly hard hit was PIMCO Total Return; some $40 billion left that fund. The assets really declined sharply, and it wasn't a point about Bill Gross or about his management style. It's just that investors wanted to avoid that interest-rate risk.
Instead they were going into short-term bond funds or funds that offered some other element of risk, such as credit risk, which might hold up better as interest rates rise.
Two categories that had very strong flows were bank loan, which are floating-rate credit securities, and the second group is non-traditional bond funds. PIMCO Unconstrained comes to mind. These are funds that can take long-short positions in credit, or shift their duration from long to short, depending upon their interest rate outlook. Those two categories had very strong flows.
A thing to keep in mind, though, for investors who might be looking at these funds, is that they are not going to provide the ballast or portfolio diversification to equities that a core bond fund is going to have. So, yes it might hold up if interest rates go up, but they are not going to be there for you when the equity market sells off.
Benz: How did those types of products perform relative to some of the core-type funds that investors were shunning last year?
Rawson: The Barclays Aggregate Bond Index, which is a broad core bond index, was down about 2%. Bank-loan funds did much better than that. They actually had a very good year, because not only do they have a shorter duration, but they also benefited from improving credit fundamentals. The economy was doing better--that's why the Fed is going to tighten, because things are looking better. So they did well.
Some non-traditional bond funds held up pretty well. Some investors I think were disappointed with PIMCO Unconstrained. It didn't deliver quite as investors had hoped. Interestingly, Bill Gross has taken over management of that fund, so I think there was kind of an admonition that the fund hadn't been doing as well as he'd hoped.
Benz: You mentioned that some of the core-type funds, such as PIMCO Total Return, were net losers in 2013's fund flow sweepstakes. Also in that category would be muni funds.
Rawson: Absolutely. Whereas some offsetting inflows came into taxable-bond funds on the short-term side and the non-traditional side, for municipal bond funds, it was outflows everywhere. Not only did we have the interest-rate risk, but you also had some credit concerns with Detroit filing for bankruptcy and Puerto Rico--which you would think, why do I have to worry about Puerto Rico in my municipal bond fund? A lot of single-state funds, maybe in an Illinois or Pennsylvania municipal bond fund, held Puerto Rico bonds because they are non-taxable. So, essentially investors were surprised by this. A lot of them exited these bonds funds, because credit spreads in Puerto Rico debt had widened.
Benz: Mike, let's look at alternative-type funds. You noted that some alternatives actually saw really nice flows in 2013.
Rawson: The big fund was MainStay Marketfield Fund. This is a long-short fund. It had about a $13 billion inflow last year--just phenomenal growth. The alternative category overall has had very strong growth. That's why we talk about it, even though it's relatively small in terms of total assets. The fund industry is really excited about getting their hands on some of this money that has been going to hedge funds.
This MainStay Marketfield Fund has had good performance really over the last five years; it remains to be seen if that could hold up especially with the assets skyrocketing as they have.
Benz: Has performance been good on that front?
Rawson: Performance has been good. The last five years, it underperformed the S&P 500, but it did so with less risk--what we call the Sharpe ratio was good. The question is, are some people going to look at their statements and say, I would have been better off in the S&P 500, and maybe not understanding the concept of why you'd want to hedge.
The other thing that's interesting about this alternative category: Coming out of the Bernie Madoff scandal, a lot of investors are thinking that, I don't want these private hedge funds. I want something that is more liquid, more transparent, that I could sell and may be lower-cost than a traditional hedge fund. But someone still has to remind them that these funds aren't going to perform as good as the stock market when the stock market is up. So, we'll see if these flows continue to be strong as investors realize how strong the market has been.
Benz: A couple of other categories that investors sometimes look to diversify market risk--gold and commodities--you noted that they were really in the losers column for 2013.
Rawson: This is a clear sign of investor confidence when people are selling their gold. Gold is a disaster trade. It's a fear trade. People exited gold. Certainly we heard a lot of speculation that hedge funds were exiting gold, and I think it's because investors are more confident in the economy. They recognize that the Fed is not going to keep the printing press on indefinitely, that they are going to start to withdraw some of the stimulus. That rampant inflation that investors feared hasn't materialized. Even TIPS, Treasury inflation-protected securities, sold off, as well as gold and gold funds.
Benz: Mike, thanks so much of providing the roundup.
Rawson: Thanks, Christine
Benz: Thanks for being here. I'm Christine Benz for Morningstar.com