Christine Benz: Hi, I'm Christine Benz for Morningstar.com. 2016 was an eventful year for mutual fund investors. Joining me to share his perspective on some of the headlines is Morningstar's director of manager research, Russ Kinnel.
Russ, thank you so much for being here.
Russ Kinnel: Good to be here.
Benz: Russ, let's start by talking about performance at a high level. We saw this tremendous rally following the election, and it really was a reversal certainly for equity fund performance. Let's talk about what changed following the election, what categories started to outperform and what categories began to underperform in the fourth quarter.
Kinnel: Yeah. We've seen energy and some financials doing really well, mainly in anticipation of a different regulatory environment. And we've seen healthcare stocks have been split; hospital stocks getting hurt, drugmakers doing a little better. And then, the biggest downside story though has been bonds have really sold off sharply on the idea that maybe America's balance sheet will get worse with tax cuts and infrastructure spending coming down.
Benz: So, within the fixed-income category, let's talk about some of the specific fund categories that were hardest hit during this period.
Kinnel: Yeah. So, it's really a matter of duration. So, the longest-term bond funds got hit the hardest; the shorter-term ones did better. High-yield is still in nice shape, year to date. And then munies are another area worth pointing out because munies suffered not just from the issues we talked about but top tax rates are a big deal for munies, because we look at them on a post-tax basis. And so, if that tax-free income loses some appeal when you cut the top tax rates and therefore munies have sold off pretty sharply postelection.
Benz: And as a part of the issue that a lot of the muni issuance is kind of longer-term, and so they naturally are more vulnerable when you are worried about interest rates?
Kinnel: Exactly. Most muni funds are in the long-term category. So, they are pretty vulnerable to interest rates, and then obviously, the tax rate issue is a second hit to munies. So, they have definitely come back a bit.
Benz: Let's talk about another story, and this is really not just a 2016 story but a multiyear story. It's been the uptake of passive products at the expense of active funds. Let's talk about what's been going on there, what you think is driving that trend and whether you think it will abate anytime soon.
Kinnel: Yeah. Really, I think, passive investing has really continued to win individual investors, advisors, and really the debate--if you hear people debating an active versus passive, the tenor is very strongly pro-passive. And so, we're seeing massive amounts go into Vanguard, both on the open-end and ETF area. And then lots of other passive ETFs are gaining tremendous ground. So, we're seeing a lot of money go in and then on a flip side, we're seeing money come out of active, U.S. equity in particular.
Other areas of active continue to draw assets, but active U.S. equity, we're seeing lots of outflows, especially if the fund underperforms. And you can really see a change in the dynamic that a year of underperformance, a couple of years of underperformance will trigger much more violent outflows today than say 10 years ago. So, you can really tell the tectonics have really shifted here.
Benz: So, do you think that investors perhaps are overestimating the advantage that will accrue to passive products? What's your take on that question?
Kinnel: It's tough to say. I think a low-cost index fund is a great idea.
Benz: And tax-efficient, too.
Kinnel: And tax-efficient. So, there are a lot of things going for them. Where I would say maybe they get a little carried away with is, some of the higher-cost ETFs, some of the niche ETFs are really squandering what makes indexing great. What makes indexing great is low costs, low turnover, you can cover a broad slice of the market, so you're tremendously diversified and that smooths out some of the extremes of the market. But if instead, you're going to a niche ETF that has one corner of the market, has certain regions, a certain sector or something like that, you're going to be paying more, you're probably going to have higher turnover, and you may be active--some of these people in ETFs are actually much more active than the people in a low turnover active fund because they are swapping, they are making market calls, etc. So, really, I would say, what's active and what's passive has--the lines have really blurred. And if you think about what works for passive can work for active in terms of you can have low costs, low turnover, sober long-term investment, and I think to me that's the more important thing than whether you choose active or passive is, you want a good low-cost fund, and that can come in either package.
Benz: Another thing that I know you monitor in your seat as director of manager research has been the extent to which new funds are being created, and another thing you keep an eye on is to the extent funds are being merged away, liquidated, swept under the rug. And let's talk about that. You say that 2016 is going to go down in the books as one of the years in which there are the fewest new open-end funds created.
Kinnel: Right. And I think that's really related to that story of the move from active to passive. And so, this year we're seeing essentially net creation is almost zero. In other words, when you subtract this fund destruction from creation, you get to about zero. And what's interesting is, it's almost entirely happening on the creation side. So, much fewer funds than usual have been created on the open-end side. Similar to '09, but of course '09 was coming off massive bear market when people were taking a lot of money out, becoming very pessimistic. Yet, this is happening in the midst of a very long-running bull market. So, it's really a striking point that to me just underlines how much things have changed with the move from active to passive.
Benz: So, your look at creation and destruction doesn't look at ETFs.
Kinnel: That's right. This is just open-end.
Benz: There's been rampant creation in the ETF space.
Kinnel: That's right. I'm sure that if we included ETFs, it would probably be much more like a normal year, or maybe even more because yes, ETFs continue to be created a lot, though ETFs have also been--they get culled themselves too.
Benz: Right. Another story you think is one of the biggest ones in the mutual fund space has been a couple of substories at Janus. Let's talk about that. The firm is merging with Henderson, but that's just one of the stories rocking Janus this year.
Kinnel: That's right. Janus is really an interesting story. They are merging with Henderson, and it's been billed as a merger of equals, and we're really in early stages. So, we don't really know exactly how things will shake out. But Janus just recently signaled some of how that will shake out, and they are going to merge away two of their best-known, really almost legendary, growth funds, Janus Fund and Janus Twenty are going to merge into two other large-growth funds. And it's really kind of an end of an era to see these funds that, really if you think back to the '90s, were really flag-bearers for growth. Janus was maybe the most popular firm coming out of the '90s and these two particular funds had tremendous growth and yet obviously since then the performance has come down and people are much less enthused. They've had a number of manager changes at both. So, they've really come down to earth, but it's still striking to see a firm kind of give up on its two flagships like that.
Benz: Now, U.S. fund investors know the Janus name; they may not know Henderson. So, can you give us a thumbnail view of that firm?
Kinnel: That's right. Henderson is a U.K.-based firm that's mostly focused in foreign investing. So, to a degree there's not that much overlap between what the two firms do. They do both have fixed income but not really regionally that much overlap. So, it's a fairly complementary for the most part. But as these mergers signal, that doesn't mean there won't be some meaningful changes for Janus.
Benz: OK. So, we have the Henderson merger. We have the doing away with a few of the flagship funds. The last headline under the Janus umbrella is the departure of Gibson Smith. He had been kind of heading up the fixed-income effort for a number of years. What's going on there?
Kinnel: That's right. And this actually happened months before the Henderson merger was announced. But it was a real surprise that Janus lost the manager who was running the most money at Janus, maybe the most important manager. I know Bill Gross is more prominent, but I think Gibson Smith was probably more important because he was chief investment officer, led a really strong bond team there. And so, it was a real surprise to see him leave Janus. And so, the fund's clearly a bit diminished even though the rest of his team appears to have stayed there. It's still a big surprise when you see someone still in his 40s leave the firm.
Benz: Another story I want to cover, Russ, is T. Rowe Price's Greg McCrickard on Small-Cap Stock. He has retired from that fund. Let's talk about what's going on there.
Kinnel: That's right. So, this change was not at all a surprise. McCrickard was at retirement age. T. Rowe had signaled this was in the works and coming. It happened in October. So, not exactly a surprise, but still an important change. The new manager does not have much of a track record. So, in our view, the fund's appeal is definitely diminished, but McCrickard, if you look back, had a really good record at the fund.
Benz: Let's talk about T. Rowe Price more broadly. Investors who have been avid T. Rowe Price investors have probably seen a series of manager changes. Does that make you and the analysts concerned about the firm's future?
Kinnel: A little. Most of these have been retirements, which is expected and as we've talked about and I wrote about earlier, a year or two ago, the T. Rowe managers seem to very consistently retire in that sort of 60 to 65 age range. So, in a way, it's relatively predictable, and there's two or three more who may be coming in the next few years. So, that is only slightly concerning. But we've seen some other people who are not retiring but leaving the firm. So, it's not yet a big worry, but we're watching it closely, because of course, the investment industry is all about people, and we want to see the next generation of T. Rowe managers, are they as good as the people they are replacing and obviously, we're hoping that there aren't many people who leave to go and work at other firms.
Benz: Right. OK, Russ, busy year for fund investors. Thank you so much for being here to share your perspective.
Kinnel: You're welcome.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.