Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Despite relatively good performance in the first quarter of this year, investors yanked money from stock funds in the first quarter of 2011.
Here to discuss the latest trends in fund flows is Kevin McDevitt. He is editorial director for Morningstar. Kevin, thanks so much for joining us.
Kevin McDevitt: Thanks for having me.
Benz: So, let's talk about this phenomenon with stock funds. You had relatively good performance, but overall investors did net pull money out of stock funds. What do you think is going on there?
McDevitt: Sure. Well, it's interesting. You saw actually quite strong flows in January and February of this year. Quite strong flows into U.S. stock funds in particular, which had been very unpopular for most of 2009 and 2010.
Benz: So, we thought maybe we were starting a trend, but it didn't persist.
McDevitt: Yeah, it really fell off in March, and it makes you wonder if a lot of what was happening in January and February was one-time rebalancing to some extent. It was end of year, and investors look at their statements and realized they didn't have as much equity exposure as they might want, so perhaps they were adding more to those stocks and to those funds.
Benz: But some categories of stock funds did get new assets, which were those, which appear to be popular?
McDevitt: Sure. Well, outside the U.S., you had foreign-stock funds generally doing well. You still have strong flows into emerging-markets funds, and you see much more just continuity in the international-stock space. There were strong flows into large-cap funds as well as small-cap funds too.
On the U.S. side, it's a different story. You, again, in March had flows out of large-cap funds, which is what we again saw in most of 2009 and 2010 as well, and you saw more flows into small-cap funds on the U.S. side. Again, this is in part driven by the fact that small-cap stocks have outperformed the large caps to such a great degree during the last decade, but even over the last year and even as relative valuations between large caps and small caps have gotten out of whack by some measures.
Benz: So, Kevin, you mentioned international, and it sounds like pretty broad-based flows into international despite what we saw happening in Japan and the Japan crisis?
McDevitt: Right, and just very anecdotally, it's interesting to see what happened even within the Japan stock category.Read Full Transcript
Benz: Small category, not a big one.
McDevitt: Very small category, yeah, less than $10 billion in assets for the whole category. But still even there you saw minimal outflows, if any. Actually, you saw fairly strong inflows into funds like Matthews Japan and into Fidelity Japan as well. So, you saw if anything investors looking at that as a buying opportunity despite the tragedy of the situation itself. You saw a lot of investors stepping up there. Again, that didn't seem to dissuade investors more broadly in terms of foreign-stock funds. Again, you saw pretty much a rough balance between money going into diversified emerging-markets funds, which have been doing well anyway. But then you also saw continued flows into the large-cap and small-cap, more developed-markets-oriented funds.
Benz: So, Kevin, one trend you've been watching for a while now is the bond space in effect that investors seem to be very much embracing risk taking. So, bank loans continue to see big flows; high yield to a lesser extent is also seeing big flows. What's going on there?
McDevitt: Sure. Frankly, I think it's a chase for yield. Again, with money market accounts and short-term bond funds generally yielding so little, I think a lot of investors feel like they are being pushed into these riskier parts of the market. And I think with bank-loan funds in particular, as we've discussed in the past, you have less interest-rate risk than you have with high-yield funds. So, you have strong yields, but also not as much interest-rate risk. So, if you're worried about rates going up that's a good place to be, in theory.
But, again, we've seen just incredibly strong inflows there over the last year. You've seen $27 billion going to bank-loans funds, and again, we worry that to some extent investors may not necessarily know how much risk they are taking on the credit side.
Benz: Their credit sensitivity.
Benz: Yeah. Kevin, in related vein, you did some work on the percentage of overall assets in some of these categories that belong to retail mutual funds. Talk about what you found there?
McDevitt: Sure. We just wanted to get a sense of how much of an impact are flows, into these given categories, having on the broader market themselves.
McDevitt: So, looking at a market like high yield, if you look assets across all high-yield funds, that's about 18% or so of the overall high-yield market. If you add in high-yield holdings for other bond funds, that actually kicks it up to about a third of the entire high-yield market being accounted for by mutual fund assets. It's smaller on the bank-loan side. There it's only about 12% of the market.
But what's interesting there is given the fact we've had such a surge of inflows over the last year into bank-loan funds, we think that those funds are actually having a big effect to the market in terms of that new money is really creating opportunities for issuers of bank loans. These bank-loan funds are, in many ways, the new incremental buyer. There are new source of demand for companies looking to issue bank loans. So, if flows were to taper off or to fall off dramatically, that will have a real impact, I think, on the underlying bank-loan market.
Benz: Interesting. Kevin, I also want to take a look at families, fund families. This is something else we've been talking about off and on. I want to take a look at some of the ones that have been the biggest beneficiaries of cash as well as firms that have been seeing outflows. Let's start with the firms that have been the biggest asset gatherers.
McDevitt: Sure. It's kind of the same old story to some extent, Vanguard and PIMCO, yeah, have just been dominating and they continue to dominate. We are seeing some new names on that list to some extent DFA, Dimensional Fund Advisors, has been creeping up the list for quite some time.
Benz: Part of it is an increased interest in passive investing that we've been observing.
McDevitt: Absolutely. And a few of their specialty areas are also areas of the market that have been doing well. They focus on emerging markets and have a few small-cap-oriented funds, as well. So, again, you're right, it's kind of a confluence of factors for DFA passive, emerging markets, and small caps, all kind of dragged intentionally these days.
Benz: And a lot of the right places. How about American funds? That's another situation we've been monitoring where investors have been yanking?
McDevitt: Right. And by American funds standards, it's been a slow trickle. They saw about another $5 billion or $6 billion in outflows, estimated outflows this past month, which is pretty much in line with what we've been seeing for quite some time.
But keep in mind that with American, their overall asset base, in just mutual funds, is about $980 billion. So on a percentage basis, it is not terribly significant for American and especially with the fact that the market has still been so strong that their overall asset base is not that affected by these outflows.
Benz: Well, Kevin, thanks so much for sharing your insights. We appreciate it.
McDevitt: Thanks for having me.
Benz: Thanks for watching. I am Christine Benz for Morningstar.com.