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Investors Come Back to Stock Funds

Christine Benz
Michael Rawson, CFA

Christine Benz: Hi, I'm Christine Benz for After retreating from equity funds for the past several years, investors actually began buying them in January 2013. Joining me to provide some color on the latest asset-flows data is Michael Rawson. He is a fund analyst with Morningstar.

Mike, thank you so much for being here.

Michael Rawson: Thanks for having me, Christine.

Benz: So, let's discuss the headlines, Mike. Active equity funds and equity funds, in general, actually began to see positive flows in their early innings of this year. What's going on there?

Rawson: I think it's really a story of a rising tide lifting all boats. There were just tremendously strong flows across the board. So, we had $115 billion come in last month. That's the most money we have ever seen come into open-end mutual funds and ETFs in one single month. So, across the board, most asset classes attracted new flows.

Benz: So, there have been a lot of people waiting for this great rotation. We have seen very strong flows into bond funds for the past several years. You think it's probably too early to call the equity fund flows a trend.

Rawson: Yes, it's just one month of data, so investors need to be mindful of that. And I am not really sure who is calling it a great rotation. There is a lot of talk in the media about this great rotation. From what I have seen, there is two versions of this story.

One version has it that people are going to start selling bonds and rotate into U.S. stocks. And it seems like there was a little bit of evidence to support that in January.

Another version of the story has it that people are going to go from cash and very low-risk assets, such as government bonds, into riskier assets, and there is evidence to support that theory, as well. But we have to be mindful of the fact that January is a seasonally strong month. You have a lot of people with the start of a new year are making lump-sum contributions into IRAs or retirement accounts, and that really seemed to be a big driver of flows last month.

You also had companies accelerating dividend payments into the end of last year. There was talk that if capital gains or dividend tax rates increase next year, the companies wanted to prepay those dividends.

So, that may have brought forward some flows that we wouldn't normally have seen. A lot of money came into money market funds at the end of last year. Bank deposits ticked up a little bit. It seems that in January some of the money that would have normally gone into money market funds, or would have normally gone into the bank, came into the markets.

So, those are phenomena, kind of, that are seasonal that probably won't persist. So, I think it might be premature to call it a great rotation.

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Benz: And you also noted that even though domestic-equity funds had decent flows, so did bond funds again and international equity, as well?

Rawson: Absolutely. Yes, the story was strong flows to U.S.-stock funds for the first time in a long time; so that's newsworthy. But still the strongest flows were to taxable-bond and international-stock funds, particularly diversified emerging-markets funds. Investors are still in love with emerging-markets funds.

So, it's not so much that there is a rotation out of bonds as it is that there was just an influx of money coming into the markets. I believe that some of that money that would have otherwise gone into the bank funds or low-risk funds was finding its way into riskier categories. For example, government-bond funds were one of the few categories which actually saw outflows last month. So, it appeared that people were willing to step up and take more risk.

And you also had last month, we saw Treasury rates tick up a little bit. The 10-year Treasury rate went up to about 2%. So, some bond funds lost a little bit of money last month. Well, of course, equities have been really strong, with 16% return last year, a 5% return in January. So, with investors' asset allocations just without rebalancing, you are shifting more into equities just from the appreciation of stocks.

So, there is some truth to this idea that investors, even though they're not putting tremendous amounts of new money into stocks, just from market appreciation your allocation to stocks has increased.

Benz: And you also noted that equity precious metals actually led the pack in terms of outflows?

Rawson: Yeah, there were some outflows there. So, safer assets, maybe risk-off-type trades lost a little bit of assets last month.

Benz: Let's take a look, Mike, at the fund families that have been seeing good inflows. Vanguard led the way in January. What funds have people been buying in the Vanguard lineup?

Rawson: It was 1, 2, 3, for Vanguard. They swept the leaderboard I guess you could call it in terms of the funds which had the most inflows, and they were all index funds. And I think what was driving that was again this seasonal inflow of money into retirement accounts. So, people were just buying maybe their default choices in their 401(k) plan or their IRA plans, where money is going into just passive index products.

So, those led the way. I thought it was interesting that in terms of PIMCO, PIMCO also had strong flows last month. But a lot of the money instead of going into PIMCO Total Return, which is their flagship fund, a lot of it went into maybe riskier funds or funds that were willing take on more risk. So all PIMCO All Asset All Authority had very strong flows. That's a PIMCO fund of funds, which is subadvised by Rob Arnott where it buys other PIMCO funds. So, PIMCO just had tremendously strong flows last month again, as well.

Benz: Backing up to this passive/active divide, you noted that active funds actually saw some inflows in the month of January, and I think what you would say is that that's probably too soon to call that a trend, too?

Rawson: I think it'd be so soon to call that a trend. I mean, I do think it probably will persist. I think we're going to see stronger flows into active equity funds over the next year. I mean we just had such strong flows into exchange-traded funds and index products that as the macroeconomic environment settles down, which feels like it has somewhat, it will return to being a little bit more of stock-pickers market, and stock-pickers will probably have an easier time going forward. That's somewhat speculative. I don't know if that's going to be the case or not, but I think that the trend of selling active equity funds is probably not going to be as strong as it has been in the past.

Benz: And just to clarify, here we're talking about open-end traditional mutual funds, not ETFs, but we have seen relatively robust flows into ETFs, as well?

Rawson: Oh, yes. ETFs had a very strong month. In fact, the last two months combined were the strongest two months that ETFs have ever had. So, there is a lot of flow going into ETFs. That trend continues. I don't think that's going to stop. And, of course, there are many different ways people use ETFs. You've got them being used for buy-and-hold investors, who like the appeal of the index funds at a low cost for a very long term. But you also have the more tactical traders using ETFs to place bets, and we saw some of that last month. And in fact, some of the biggest funds that had outflows were the government-bond ETFs, which I thought was interesting because I think that's more speculative money, where people are saying, "Well, I think interest rates are going to go up, so I'm going to get out of these government-bond funds."

Benz: Well, Mike, thank you so much for providing color on the latest data.

Rawson: Thank you, Christine.

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

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