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By Christine Benz and Timothy Strauts | 08-14-2014 10:00 AM

Indexing Gains Ground, but Not Everywhere

Passive funds continued to attract investor dollars in July, but active management is still preferred for overseas exposure.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

Amid a volatile equity market, investors pulled assets from U.S. stock funds in July. Joining me to discuss the latest fund flow data is Tim Strauts, a senior analyst with Morningstar.

Tim, thank you so much for being here.

Tim Strauts: I'm glad to be here.

Benz: Tim, when you look at the headline numbers for U.S. equity mutual funds, we actually saw larger-than-typical outflows in the month of July. The markets were volatile. Do you think it's simply that investors were feeling a little bit spooked?

Strauts: U.S equity funds saw a little over $11 billion in outflows in July, which is an accelerating pace over the last three months. Now, obviously, negative returns affect that, but I think it's also a thought that's been present in the media that the U.S. market may be a little overvalued. It may have gone up so fast over the last 18 months that it may be time for a cool down in the U.S. market.

Benz: Time to take some profits. I have been advising investors to rebalance.

When you add back in what's been going on in exchange-traded funds--we were talking about just mutual funds before--when you add ETF flows in, how does the picture look for domestic equity?

Strauts: The picture changes dramatically when you look at ETFs. Just in July the negative $11 billion outflow turns into only a negative $1.7 billion outflow when you factor in ETFs.

And on a year-to-date basis, U.S. equity mutual funds had a negative $4 billion total outflow, but when you add ETFs in, it turns into an $8 billion inflow. There is definitely a trend here. Maybe investors are moving from their mutual funds to ETFs.

Benz: And even among investors who are sticking with traditional mutual funds, we are also seeing them swap from active products into index-type mutual funds.

Do you see anything reversing this trend? We've been monitoring it for a few years. Or do you think that investors will continue to make this switch?

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