U.S. Fund Investors Head for the Exits

The past couple of months have given investors plenty to worry about, and they responded by yanking cash out of mutual funds in May. Overall, long-term mutual funds registered outflows of $13.2 billion for the month entirely because of massive redemptions from equity funds.

While money market funds also saw outflows, the size of those outflows declined considerably, suggesting that some of the money exiting mutual funds sought safety in money market accounts. The $20.6 billion in money fund redemptions in May was roughly 20% of the average outflow experienced so far this year.

Even though credit worries in Europe dominated the headlines, investors took out their frustrations on U.S. stock funds. Almost $15 billion left the asset class in May for the largest monthly outflow since March 2009--the month that marked the beginning of the market recovery.

The European economic woes brought an end to a long streak for international stock funds. After 13 straight months of steady inflows, the asset class saw redemptions of almost $6 billion in May.

Bond funds maintained positive flows for the month, but enthusiasm for the asset class cooled considerably. Taxable bond funds took in just $4.8 billion. That dwarfs the results seen in recent months and is the smallest monthly inflow since August 2008.

Taking Risk off the Table
As volatility returned to the market in May, investors responded by ditching riskier investments in favor of more sedate ones. That manifested itself not only in the broad move from equities to bonds, but also in the flows within the fixed-income space.

While most bond categories saw positive flows in May, high-yield bond funds had to deal with massive redemptions. All but 34 of the 146 funds in the group registered outflows in May. By the end of the month, $6.3 billion had left the category, which is the largest monthly outflow since our records begin in 1998.

At the opposite end of the spectrum, short-term bond funds attracted $4.0 billion in new cash. That category has experienced strong and steady inflows since the beginning of 2009. That year, short-term bond funds took in a record $50.5 billion, and they appear to be on track to meet or exceed that record in 2010, with $23.1 billion in inflows through the first five months of the year.

Passive Fund Investors Show More Loyalty
Actively managed funds, which reported redemptions of $16.5 billion, were responsible for the outflows out of U.S. stock funds in May. Passively managed funds managed to maintain positive flows of $1.0 billion for the month. That's a continuation of a long-term trend. Actively managed stock funds have struggled to hold on to shareholders, but passive funds appear to have a more loyal investor base.

Vanguard and American Funds have been at opposite ends of that trend. Vanguard's share of the mutual fund market has increased from 14% at the beginning of 2008 to 15.5% today. Meanwhile, American Funds has seen its market share decline from 15% to just over 12% over the same period.

Investors Show New Faith in Emerging-Markets Bond Funds
The credit crisis in Greece and its implication for other highly leveraged countries clearly spooked investors in May. But while developed economies struggle under historic debt loads, many emerging-markets countries have worked hard to clean up their balance sheets. Record flows into emerging-markets bond funds suggest that investors' perceptions about the risks of emerging-markets debt have changed. Flows into emerging-markets bond funds have increased at a steady clip since mid-2009. Over the past 12 months, the category has raked in almost $10.0 billion, which amounts to 72% of the assets under management at the beginning of that period.

Two PIMCO funds have been among the preferred vehicles for gaining exposure to emerging-markets bonds: PIMCO Emerging Local Bond (PELAX) leads the category with $2.3 billion in inflows over the past year, and  PIMCO Developing Local Markets (PLMAX) has taken in $1.4 billion over that period. Other category contenders include  MFS Emerging Market Debt Fund (MEDAX) and  T. Rowe Price Emerging Markets Bond (PREMX) with 12-month flows of $1.6 billion and $1.2 billion, respectively.

Are Investors Chasing Yield?
Many have speculated that the enormous flows into bond funds over the past couple of years have partly been motivated by yield-chasing. But the fund flow data doesn't help support that argument. The typical taxable core bond fund has generated a 12-month yield of 4%. Funds with yields greater than that have captured less than 15% of inflows into taxable bond funds since January 2009. We've seen a similar pattern for muni funds. Funds with yield greater than 4% account for roughly 10% of flows since the beginning of 2009. The majority of the muni fund flows have gone to funds with yield ranging from 2% to 4%.

Still, that doesn't necessarily prove that yield-chasing isn't going on. Some of the huge inflows into bond funds have likely been funded by assets that normally would be allocated to money market accounts or CDs. But the minuscule payouts on those investments have likely pushed income-hungry investors out the yield curve into bonds funds. Massive flows out of money market funds and steady inflows into short-term and ultrashort bond funds support that theory.

Big New Kids on the Block
Excluding target-date funds, around 80 new funds have launched in 2010, and a handful have enjoyed early success in gathering assets. The top newbie is  DoubleLine Total Return (DBLTX), which has amassed total net assets of $610 million since its early April debut. That fund is run by star fixed-income manager Jeffrey Gundlach, who formerly ran  TCW Total Return (TGLMX).

PIMCO's foray into the equity arena has also gotten off to a strong start. PIMCO EqS Pathfinder , which launched in April, stands at over $500 million in net assets as of May 31. While PIMCO's equity efforts are in their early stages, they have attracted a team of seasoned and proven managers to lead that effort--Anne Gudefin and Chuck Lahr, two Mutual Series alums who ran  Mutual Global Discovery (TEDIX) before moving to PIMCO.

AQR Global Equity (AQGIX) debuted at the beginning of the year and weighed in at $350 million in net assets at the end of May. This open-end fund provides a way for retail investors to gain access to the hedge fund-like strategy deployed by Cliff Asness and his team.

Fairholme's fixed-income offering,  Fairholme Focused Income (FOCIX), opened for business in January and now stands at $249 million in assets. Manager Bruce Berkowitz's success in the equity arena has likely attracted investors to this wide-ranging and concentrated bond fund.

Open-End Fund Family Highlights

Source: Morningstar Direct Fund Flow

Ameriprise's acquisition of Columbia Management was finalized in May, but the uncertainty that often arises from these deals appears to have made investors wary. Columbia funds have seen steadily increasing outflows throughout 2010, totaling $2.0 billion through May.

Investors withdrew $4.6 billion from Fidelity funds, which was the largest monthly outflow for the firm since October 2008. Inflows into Fidelity's  target-date series and its bond funds could not counteract the redemptions from equity and high-yield funds. May's outflows offset inflows over the two previous months and took Fidelity's year-to-date inflow to just $92 million.

 PIMCO Total Return (PTTRX) continues to be the biggest-selling U.S. fund, but PIMCO Unconstrained Bond (PFIUX) has experienced even faster growth lately; the fund's total net assets have almost tripled since the end of 2008. It was the second-most popular fund in May, with $1.6 billion in new flows, and it has taken in $4.7 billion in new assets so far this year.

Although BlackRock increased its footprint exponentially with the acquisition of iShares' ETF business last year, that's overshadowed the strong recent growth in its mutual funds business. With inflows of $5.8 billion so far in 2010, the firm appears on pace to break 2009's record inflows of $10.3 billion. The firm has a strong reputation in the fixed-income arena, and its bond funds have contributed to its growth, but  BlackRock Global Allocation (MDLOX), a world allocation fund, is the firm's top seller so far this year, followed by  BlackRock Equity Dividend (MDDVX).