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When Investors Leave Your Fund, Should You Follow?

Christine Benz
Michelle Ward, CFA

Christine Benz: Hi. I’m Christine Benz for

Actively managed funds have seen $100 billion in outflow so far in 2012, and certain funds have been particularly hard hit.

Joining me to discuss some recent research in this area is Michelle Canavan. She is a mutual fund analyst with Morningstar.

Michelle, thank you so much for being here.

Michelle Canavan: Of course, thanks for having me.

Benz: You issued a recent research report, Michelle, where you looked at certain funds that have seen big outflows, and let's talk about how that can potentially create havoc for the funds and their eventual performance. Let's talk about the structural things that can happen to a fund. If the manager is seeing a lot of outflows, how can that effect how he or she is managing that portfolio?

Canavan: First you can distract managers from their primary job, which is really stock-picking. Instead they have to focus their time on figuring out what to sell. And for managers who invest in less liquid asset classes, small cap for example, when they're forced to sell positions when they're not quite ready, it can put additional downward pressure on prices.

Another part of the distraction is that managers end up spending more time meeting with investors and pacifying their client base and spending time explaining why they're underperforming, but why they can get back on track. So, it just takes them away from their primary duty of picking stocks.

Benz: Is there the potential, too, for the manager to maybe hold more cash than he or she otherwise would because they're seeing these outflows and might expect them to continue?

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Canavan: Yes, that's definitely a concern, too. If they expect more redemptions to come in the coming months, they might end up pulling excess cash in making sure they have enough to meet those redemptions.

Benz: You also highlighted in your article, Michelle, that there can be sort of operational hurdles that crop up when a fund family is seeing a lot of redemptions. Let's talk about some of those--and one of the funds you’re going to highlight has actually seen some changes in its personnel due to redemptions?

Canavan: Obviously, a decrease in assets can lead to a decrease in profits. When that happens, some of the resources might have to be let go, and they can be stretched more thin, and that's what happened at Artio, for example, recently as they had to let go some resources from various areas of the firm.

The problem with that also is that management may not be able to travel as frequently to meet with company management, and they might have trouble recruiting. They may not even be able to necessarily have any additional hires, and at the same time they may have trouble retaining their top investment talent, which makes getting the performance back on track even more difficult.

Benz: Two of the funds that you highlighted in your article, Artio Global Equity and Artio Global Equity II, I’d like to drill in on those two, in particular. Their asset outflows have been really stunning at $35 billion in those two products at the end of 2007, now down to $3.1 billion. So, a very dramatic level of outflows. First of all, what have investors been responding to? Why have they been pulling their money?

Canavan: It has been a prolonged slump really since 2008’s downturn. The funds have both underperformed pretty spectacularly over that time, and their three- and five-year returns end in the bottom docile, and even their 10-year returns, which used to be really off the charts, are even middling.

So, I think investors have maybe lost patience in the investment strategy, because the two managers who have been there since really the inception of the funds are still on board, but I think … investors have just lost their patience and have been looking elsewhere for their international equity exposure.

Benz: You noted that there have been some changes behind the scenes at the firm, too, from a personnel standpoint. Let's talk about that?

Canavan: Sure. So, they have definitely had to have some layoffs and let go some of their resources. And earlier this year, Artio also shuttered their U.S. equity funds--presumably just the small asset base wasn't worth the costs. So, I think investors maybe see that and start worrying about maybe the viability of the firm going forward. And I think that getting these two funds back on track is really crucial for the long-term health of the firm.

Benz: I know at one point we liked the funds in the firm quite a bit. Where do they stand now in terms of their Analyst Ratings, given these issues that we've been seeing going on?

Canavan: So, when the analyst ratings were first launched in November 2011, both Artio International Equity and International Equity II were launched with the Silver rating, and in the past month or so, they both were downgraded to Bronze, and the prolonged performance struggles were certainly the driving force behind the Analyst Rating [change], but I think that the additional issues at the firm and just concern over the long-term health of the firm played a part in downgrading those to Bronze.

Benz: Another fund that you think exemplifies this issue of redemptions is Nuveen Tradewinds Global All-Cap. It's a fund that you highlighted as having a recent manager change and that has, in turn, sparked some redemptions it sounds like, and a change in our outlook for the fund?

Canavan: Yes. So, David Iben, who is the chief investment officer of Tradewinds and the lead portfolio manager on a number of funds, announced in March that he was leaving the firm, and he was also taking a few analysts with him.

Nuveen Tradewinds didn't have a natural successor in place, and a lot of analysts on the team that were remaining don't have a public track record of managing assets. So, over the next couple of months, the Nuveen Tradewinds funds that David Iben managed had seen pretty massive outflows, and at that time, the analyst on those funds re-evaluated the rating, and at this time, it's rated Negative.

Benz: It's a combination of factors, it sounds, that have conspired against the fund in terms of its rating, so the manager change, it sounds like, was sort of the driving force.

Canavan: Right. I think it was the driving force for the Analyst Rating [change], and I imagine also the driving force, too, [behind] the massive outflows that the funds have seen this year.

Benz: Right. Last fund I wanted to talk about that you highlighted in your report is Brandywine Blue. It sounds like there have been performance issues there, and subsequently redemptions, which is a pattern we often see.

Canavan: Right. Brandywine Blue, the veteran manager, Bill D'Alonzo, remains onboard, but the fund has struggled most recently, and I think their long-term trailing returns all land in the bottom quartile at this point. So, I think it's just another instance where investors have really just lost confidence in the strategy. So, they've also seen pretty substantial outflows this year.

Benz: How about in terms of a broad takeaway? Even if you don't own one of these specific funds, if you start seeing a huge rash of redemptions at your fund, what should you do? I know we often counsel investors to be contrarian, to swim against the tide. But in this case, is it maybe a reasonable thing to do to join the others heading for the exits?

Canavan: I don't think it's always necessary to follow the herds to the exit. But I think anytime you see significant outflows in the funds that you own, it's definitely time to re-evaluate the fund, re-evaluate the merits that caused you to first buy the fund, see if those are still there, and then make your decision from there. But in any case, I think it's definitely a red flag and something that should encourage you to re-evaluate your investments.

Benz: And the Analyst Reports and the Analyst Ratings actually walk investors through the process of doing that evaluation, so it's helpful stuff at a time like that, too?

Canavan: Yes, definitely.

Benz: Michelle, thank you so much for being here today.

Canavan: Thank you for having me.

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