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By Christine Benz | 01-12-2012 11:00 AM

Investors Steer Clear of Risk in 2011

Investors piled out of U.S. long-term stock funds last year and toward safer options at the greatest rate since the peak of the financial crisis in 2008.

Christine Benz: Hi, I am Christine Benz for Morningstar.com. Flows into mutual funds were anemic in 2011, the industry's worst showing since 2008. Here to shed some light on the latest trends in inflows and outflows into mutual funds is Kevin McDevitt; he is editorial director with Morningstar. Kevin, thank you so much for joining me.

Kevin McDevitt: Thanks for having me, Christine.

Benz: So Kevin, the industry overall had a pretty weak year with just about $55 billion flowing into long-term mutual funds. Investors were buying some areas, but obviously selling some others. What were the hardest-hit spots?

McDevitt: By far the biggest disappointment or the hardest-hit area was U.S. stock funds. In 2008, you had about $121 billion in outflows, but again, considering that the market was just flat this past year, albeit with lot of volatility, with a nasty correction thrown in, too, you still had outflows in a year, in which the S&P was up 2%.

Benz: Right. So, was the selling broad-based would you say, Kevin, or was it coming out of certain types of funds within the U.S. equity space?

McDevitt: Throughout the year we saw really heavy selling in the large-cap categories, and large-cap growth in particular saw the heaviest selling, pretty much wire to wire. You saw the greatest selling there, particularly funds like American Funds' Growth Fund of America, and to put into perspective, Growth Fund of America had about $33 billion in outflows by itself for the year. And to give you an idea just of the magnitude, that's more than any other fund family had for the year. Fidelity came in second with about $28 billion or so in outflows. So, again, that just puts that in perspective. But outside of large-cap funds generally, as the year went on, you didn't see as much selling out of the small- and mid-cap categories early on. But as things went on, as the year progressed, you started to see more selling in those small- and mid-cap categories, too, so that by the end of the year, it really was very broad-based across all categories.

Benz: Of course performance was also worse in the small- and mid-cap categories in general, in 2011?

McDevitt: Right. Certainly in the second half of the year.

Benz: Kevin, I would like to focus a little bit on international funds. The group did have some modestly positive inflows, but you observed a real dichotomy there, with assets flowing out of developed-markets funds, and into developing markets. What's your take on why that happened, given that emerging markets weren't all that great or were in fact very weak in 2011?

McDevitt: Well, it raises the question of how much performance does actually influence investor behavior. And I think that, investors do still respond to returns, but what we see here is that there is very much of a lag. To spell it out, for the year, you had inflows into diversified emerging-markets equity funds of about $20 billion. Very strong inflows, even though that was by far the hardest-hit category last year; I believe the average diversified emerging-markets fund lost close to 20%. On the flip side of that, the most redeemed category among international-stock funds was in world-stock funds, which actually had the best relative returns, due in large part to their fairly healthy U.S. stake that most of those funds have. But again, it was interesting that as you said, you saw the most extreme outflows, the most extreme negative set coming for world-stock funds.

Benz: So you think, either investors are buying into the long-term growth story of developing markets, or maybe they are looking at the three- and five-year view and seeing the robust returns, probably one or the other scenarios figuring into why investors continue to put money in emerging markets?

McDevitt: Right, I think it is a bit of both. I think it's just the strength and the endurance of the emerging-markets story, and just wanting to diversify outside the U.S., looking for areas where there might be some growth going forward. Then as you said, surely returns for emerging-markets equity funds are still very strong, if you are looking out, five to 10 years in particular. So I think that it would be interesting to see how things shake out in 2012, if investors will continue to put money into emerging-markets funds. Also that said, you did see a bit of a drop-off these last few months in emerging-markets-stock fund flows. For the first time in a long time, they were below $1 billion this past month, in December. So you are seeing declining interest, or at least declining positive sentiment, and it'd be interesting to see if that continues, if you eventually see outflows even perhaps in emerging-markets-stock funds.

Benz: Kevin, I would like to shift gears and talk about a more positive story for the industry. Whereas investors have been dumping equity funds, they were buying bond funds, and taxable bond funds in particular were the biggest beneficiaries in terms of new assets. Can you shed any light on what particular categories were garnering new inflows during the year?

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