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By Christine Benz and Michael Rawson, CFA | 11-13-2013 10:00 AM

A Rising Tide Lifts Active Equity Inflows

While investors continue to devote money to passive equity funds, active equity offerings also picked up a decent chunk of investor dollars last month.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Recent fund flow data indicate that investors continue to prefer equity funds. Joining me to discuss the recent numbers is Michael Rawson. He is a fund analyst with Morningstar.

Mike, thank you so much for being here.

Michael Rawson: Thanks for having me, Christine.

Benz: Mike, the headline is that this great rotation actually seems to be for real, at least if you are looking at equity fund flows. What kinds of stock funds have investors been buying?

Rawson: We started the year talking about the great rotation from bonds into equities. It hasn't quite played out that way. Certainly, there have been outflows from bond funds. Active equity hasn't really been that strong, but last month active equity actually picked up quite a bit. There were strong flows to passive, as usual, but this is only the third time this year, the third month, that active had decent inflows.

Definitely, the outflows that we saw from active equity last year have totally subsided, and now we're seeing some modest inflows. So that was interesting to see.

Benz: I want to talk about what's going on with international equity, because that's been the real bright spot, but let's talk about what sorts of products people are buying within the domestic equity realm.

Rawson: They're buying large-cap funds. Large cap, obviously, is the bigger part of the market. They're also still continuing to seek out the value side--that's where the dividend-paying stocks are. Value tends to be outperforming growth in terms of flows.

On the ETF side, there was some heavy selling actually out of the small-cap funds. The Russell 2000 iShares fund actually had some heavy selling, and that's a little bit more understandable. Some small-cap indexes are up by 30%, so they have had a tremendous run. They certainly look expensive probably [compared] to large caps, which look more fairly valued. And there still continue to be positive inflows into large-cap funds.

Benz: This international flow story confounds me, because international equities have actually underperformed U.S., and we don't typically see investors responding to valuations when they decide where to allocate new dollars. They tend to respond more to performance. What do you think is going on there, Mike?

Rawson: Finally, it doesn't look like people are looking in the rearview mirror to determine where to put their money, which is a good thing. You look at Europe, valuations are more attractive. The financial situation in Europe seems to have stabilized. We don't have as many negative headlines as we did last year. So, a lot of flows are going into Europe or foreign large-blend, global allocation funds, which would have a big stake in Europe. So, the flows there are very strong. There still continue to be good flows into emerging-markets funds on the mutual fund side, not as much on the ETF side.

But I think this is a good thing, because investors tend to have what we call a home-country bias, where you tend to have most of your assets in your home country, and that's a risk, because, obviously, your livelihood is correlated to the economy in your home country. It's good to have some diversification and put some assets internationally. So, we are seeing strong flows internationally, and that's probably a good thing.

Benz: In terms of passive versus active on the international side, any trends that you've gleaned there?

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