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By Christine Benz and Dan Culloton | 08-06-2015 03:00 PM

Should You Buy or Sell Funds Based on Flows?

New Morningstar research indicates that flows can have a significant impact on a fund's future prospects.

Christine Benz: Hi, I'm Christine Benz from Morningstar.com. What impact do fund inflows and outflows have on a fund's prospects? Joining me to discuss some research on that topic is Dan Culloton--he is associate director for equity manager research for Morningstar.

Dan, thank you so much for being here.

Dan Culloton: Thanks for having me, Christine.

Benz: Dan, you looked closely at this topic in the recent issue of Morningstar FundInvestor. Let's talk about the types of funds that you looked at when conducting this research and also how you managed a fund's subsequent success or failure. What did you look at?

Culloton: We looked at domestic and foreign funds. We looked at large-cap, mid-cap, and small-cap domestic funds, and then large-, small-, and mid-cap foreign funds. What we did is we broke them down into deciles by inflows and outflows, with the first decile being the funds getting the most outflows--or least inflows--and the tenth decile being the funds getting the most inflows. Then, we took all of the funds at the start of rolling three-year periods starting in 2006 to the end of 2014 and looked at subsequent three-year performance after that. We looked at absolute returns; we looked at star ratings; we looked at success ratios, which are the odds of a fund surviving and outperforming their peers over the subsequent period.

Benz: So, there are no bond funds in the mix; you just stuck with equities.

Culloton: No bond funds--just domestic equity and foreign equity.

Benz: Let's start with the funds that were garnering big inflows over these various time periods. In terms of their success rate, let's start there and talk about how likely the funds getting the biggest inflows were to survive--one would guess probably pretty likely if funds are gathering a lot of assets--and also how likely they were to outperform their peers.

Culloton: You're right. Very few fund families want to kill off a fund that's collecting lots of assets. So, their survival rates were very high--higher than 80% or 85% in most categories. Big inflow-getters were more likely to be around over the subsequent periods. Their odds of surviving and outperforming, though, were a lot lower. The actual success ratios--which, once again, includes the odds of surviving and outperforming peers--were lower than 40% among most of the categories (for the domestic large, small, and mid, as well as the foreign large cap).

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