Global Investors Shunned Risk in 2011

Christine Benz: Hi, I'm Christine Benz from Morningstar. With signs of slowing global growth, as well as the eurozone debt crisis, investors had not shortage of things to worry about in 2011. Here to discuss how that affected where global investors were placing their bets in 2011 is Kevin McDevitt. He is editorial director with Morningstar.

Kevin, thank you so much for being here.

Kevin McDevitt: Thanks for having me, Christine.

Benz: Kevin, you have said that if there's one headline when you look at global fund flows for 2011, it's risk aversion. We saw investors really reining in their bets on equity funds. What are the trends that you've seen there?

McDevitt: Sure. I think it's perhaps natural to think from a U.S.-based perspective, that what's happening in the U.S. may not be mirrored outside of the U.S. But really you've seen risk aversion, as you said, across the globe, and especially you've seen it most clearly with equity funds. Last year you had about $215 billion in outflows across equity funds around the world. That's primarily besides the U.S.; that's primarily in Europe, Canada, Australia, New Zealand, and parts of Asia. Those are the primary markets in terms of equity assets.

Really, the U.S. was only about one third of that or so. A lot of those outflows were coming from other parts of the world. Especially in Europe, that's where you saw the greatest outflows. You see that expressed in European-stock funds, but also something that's called cross-border funds. Cross-border funds are really offshore funds, funds that are domiciled in places like Luxembourg, Dublin, and Lichtenstein, places like that.

Benz: So, where were investors putting their money if they were retreating from equity funds? I know in the U.S., we've seen some strong flows in the bond funds. Did you see that trend outside of the U.S., as well?

McDevitt: No, you didn't. That was an interesting divergence with the U.S. In terms of bond funds, especially in the eurozone and this is very understandable given what's been happening in the eurozone, you saw significant outflows out of fixed-income funds. You saw it both in terms of long-term-oriented bond funds and also of money market funds. But what was interesting though unlike with equity funds, when it comes to cross-border funds, you saw inflows into both fixed-income funds and into some money market funds. And I think the explanation for that may lie in the fact that with cross-border funds or with offshore funds, if you're a eurozone-domiciled investor, you could buy a fixed-income fund denominated in different currency. So, perhaps if you wanted fixed-income exposure, but you wanted it in the Swiss franc, in the pound, or in the dollar, you have that option by buying an offshore fund.

So again, you did see outflows out of eurozone-denominated funds. You saw inflows into a lot of the offshore fixed-income funds. You saw that, too, again on the money market side. You had about $32 billion go into pounds sterling-denominated funds. The outflows out of eurozone money market accounts which is about $38 billion, roughly matched the inflows you saw into offshore money market accounts, which is about $41 billion.

Benz: So in general, investors seem to have been spooked by what they saw going on in the eurozone and were seeking relief in the other foreign currencies apart from the euro.

McDevitt: Right. You can see that. With the eurozone investors, they are seeking safe havens perhaps even more so than we are here in the U.S., and not surprisingly, the biggest outflows on the fixed-income side came out of countries like Italy and France. Italy, I believe, had about $30 billion pulled out of its fixed-income funds, and there was about $23 billion that was pulled out of French fixed-income funds. In the case of Italian fixed-income funds, that was about a quarter of all assets under management, so those are just huge outflows in the fixed income side.

Benz: Kevin, another category I'd like to cover with you is the area of commodities and the broad basket of alternative investments. I know here in the U.S. we've seen quite a bit of buzz around these categories. Are you seeing growth in assets in those categories when you look at global fund flows?

McDevitt: You are. You are seeing a strong interest in the alternatives space especially, but when we look at funds on a global basis, we separate the alternative categories from the commodity categories. What's interesting is, on the commodities side, almost all of that interest is in the U.S. Almost all the commodity flows, a little more than $9 billion in 2011, came from U.S.-based investors and went to the U.S.-based funds. On the alternatives side, you saw much more interest in genuine alternative strategies, things like hedge funds and market mutual funds. You did see that to some extent in the U.S., but even more so again overseas, especially coming out of Asia and Europe.

Benz: I'd like to back up to your point about commodities, Kevin, where you noted that the flows are driven entirely or almost exclusively by U.S. investors. Is it that the products aren't available overseas or that there simply is no demand for them? What's driving that lack of flows into commodity type products outside of the U.S.?

McDevitt: That's a great question. I imagine it's more about the vehicle itself, and perhaps investors are getting that exposure through things such as exchange-traded funds and other vehicles. It's more a matter of the fact that there aren't perhaps the products investors are interested in, in the open end, in the mutual fund space.

Benz: So when you look at traditional mutual funds, maybe the commodities products, just aren't there?

McDevitt: Yeah, we're seeing that in the U.S., too. You're seeing greater interest and perhaps more people interested in gaining their commodities exposure through things like ETFs. Even though there is still demand on the open-end side in the U.S., there certainly has been a shift toward ETFs in terms of getting commodity exposure.

Benz: Right. Now, Kevin, you just mentioned ETFs, and one other broad trend that I'd like to discuss is whether you have observed a trend toward passively managed products, such as ETFs and index funds. Has that been a global trend? I know it's certainly one that we've observed here in the U.S.?

McDevitt: Well, it's interesting. Perhaps as is the case with commodity funds, we have not really seen that trend overseas in terms of passive investing. We haven't really seen that surge of flows into passively managed vehicles overseas. Again, it might be an issue of the vehicle itself or might an issue of how those funds are sold. They're not really actively promoted overseas as much, although again, we do know that there are certainly providers overseas. But you just haven't seen the flows yet. Again, at least in terms of the mutual fund space, you haven't seen it. All those flows have really come from the U.S. We saw some tepid inflows, $2 billion to $3 billion in all of Europe, into passively managed funds, but we haven't seen anything really beyond that. It's relatively flat overall.

Benz: Well, Kevin, it's always great to see how these fund flows intersect with investor psychology, and it's definitely great to get the global view. So thank you so much for being here today.

McDevitt: Yeah. Thank you, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.