Some Surprises in August Fund Flows

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. I am here today with Kevin McDevitt; he is an editorial director at Morningstar. We're going to take a look at August Fund Flow data and see where investors are placing their bets or not placing their bets.

Kevin, thanks for talking with me today.

Kevin McDevitt: Thank you, Jeremy.

Glaser: So, just overall can you give us the big picture for what August fund flows looked like?

McDevitt: Sure. There was a huge surge in long-term outflows. Outflows almost doubled from what they were in the previous months. What was most surprising, though, is that the surge in outflows was not coming from U.S. stock funds; it was coming more from taxable bond funds.

Again, for perspective, overall long-term outflows are about $32 billion, last month about $17 billion. But last month U.S. stock outflows were about $22 billion; in August, it actually fell to about $15 billion. The real surge came from high-yield and bank-loan funds.

Glaser: So, let's go ahead and take a closer look at fixed income, then, because that seems like where most of the money was flowing out of. What do you think was causing investors to pull out of some of those instruments?

McDevitt: Some of it, I think, was just performance. You saw spreads widening in the high yield space and returns were down for the month. You saw both high-yield funds and bank-loan funds losing a little over 4%. So, I think that was part of it.

But I think also just, more generally, across the board and for most of 2011, you've seen a real reduction in risk. You've seen that in equities, but now you are seeing that more in bonds, too. Demand for high-yield funds and bank-loan funds has been declining really since December of last year, it's just that this month, it really fell off a cliff.

Glaser: You did mention that the risk is coming off the table, but we actually saw that deceleration [in outflows] when it comes to U.S. stock funds. With all the volatility that we saw in August, is that a surprising result to you?

<TRANSCRIPT>

McDevitt: It really was. I certainly thought that outflows will be greater for U.S. stock funds [in August] than they were [in July]. And don't get me wrong, $15 or so billion is still quite a bit in terms of outflows, but it certainly pales to what we saw, the $22 billion in July.

That said, this is of a piece. We've been seeing just steady outflows out of U.S. stock funds, really for years now and solidly for the last two years. So, this is a continuation of that trend, but it is somewhat surprising that we didn't see even more, considering what volatility was and the sell-off we had in August.

Glaser: How about emerging markets? Is the money that's coming out of U.S. funds flowing into developing markets?

McDevitt: Not necessarily. It's always hard to kind of trace those. But on the debt side you're certainly still seeing strong demand for emerging-market funds. On the equity side, there, too, though you're still seeing positive inflows, but it's declining interest, and again we've been seeing declining flows into emerging-market equity funds since early in the year, and I think that's not terribly surprising, given how much worse of a sell-off we've seen in emerging markets than in U.S. markets.

I believe diversified emerging-markets funds are down about 13% or so year-to-date, which is certainly worse than what we've seen in the U.S. But, that said, you could point to some resilience. We still saw nearly $1 billion of inflows into emerging-market equity funds. So, it seems like investors are making perhaps more of a long-term commitment there.

Glaser: Now, in July something that I know struck you is that money market funds lost quite a bit, there is quite a big outflow from there--investors looking for true safe havens maybe just in the savings account. Did that turn around in August?

McDevitt: It really did, quite substantially. We saw inflows of about $75 billion, which I believe was the greatest inflow at least within the last two years or so, I think going back to 2008 or 2009. I think that owed to a couple of factors: One is just this general risk aversion and investors wanting to take money out of equity funds and bond funds and move it into the money markets, but it's also reversal of flight we saw out of money market funds in June and July. And I think a lot of that was tied to the concerns about the debt ceiling, and what would happen there. And perhaps if Congress didn't raise the debt ceiling, would it lead to a frozen money market? After that concern had passed, I think investors felt safer about returning to money markets. So that, I think, explains a lot of the rebound we saw in August.

Glaser: Taking a look at fund families, were there any clear winners and losers over August, or is it just continuation of some of the trends that we've seen developing over the last year?

McDevitt: Well, there were far more losers than winners this past month among the larger fund families, just given the outflows we saw across the board on both the equity side and the bond side. But that said, there were few bright spots. The big one was PIMCO.

PIMCO had strong flows for the most part, and what I thought was surprising there was that its most popular fund was PIMCO Total Return--of course, its largest offering. But given the struggles that PIMCO Total Return has had from a performance standpoint, I found it somewhat surprising that they saw, I think, about $1.3 billion or so in inflows for Total Return. That was a bit of a surprise, but PIMCO as a family saw fairly steady flows across the board. Certainly, their emerging-market bond funds again saw strong flows this past month.

Glaser: Then what fund family saw their largest outflows in the month?

McDevitt: The biggest victims last month, again, were the American Funds and Fidelity. American for the second consecutive month had close to $10 billion in outflows and Fidelity had about $7.5 billion. Both those families have been getting hit hard for quite some time. American, in particular, it has a fairly equity-oriented lineup. It does have certainly a share of bond funds, but it tends to be a bit more equity focused, but that family, in particular, has really gotten hit hard, and again that trend continued this past month.

Same for Fidelity. Again, both families have broad lineups and are well diversified in terms of what kinds of offerings they have. But I think they both tend to be thought of as equity-oriented shops, and their equity funds have seen a lot of outflows.

Glaser: Well, Kevin, thanks so much for your thoughts today. We appreciate it.

McDevitt: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser.