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By Christine Benz and Michelle Ward, CFA | 12-12-2012 10:00 AM

When Investors Leave Your Fund, Should You Follow?

Significant outflows in a fund you own aren't an automatic sell signal, but are definitely cause to re-evaluate, says Morningstar analyst Michelle Canavan.

Christine Benz: Hi. I’m Christine Benz for

Actively managed funds have seen $100 billion in outflow so far in 2012, and certain funds have been particularly hard hit.

Joining me to discuss some recent research in this area is Michelle Canavan. She is a mutual fund analyst with Morningstar.

Michelle, thank you so much for being here.

Michelle Canavan: Of course, thanks for having me.

Benz: You issued a recent research report, Michelle, where you looked at certain funds that have seen big outflows, and let's talk about how that can potentially create havoc for the funds and their eventual performance. Let's talk about the structural things that can happen to a fund. If the manager is seeing a lot of outflows, how can that effect how he or she is managing that portfolio?

Canavan: First you can distract managers from their primary job, which is really stock-picking. Instead they have to focus their time on figuring out what to sell. And for managers who invest in less liquid asset classes, small cap for example, when they're forced to sell positions when they're not quite ready, it can put additional downward pressure on prices.

Another part of the distraction is that managers end up spending more time meeting with investors and pacifying their client base and spending time explaining why they're underperforming, but why they can get back on track. So, it just takes them away from their primary duty of picking stocks.

Benz: Is there the potential, too, for the manager to maybe hold more cash than he or she otherwise would because they're seeing these outflows and might expect them to continue?

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