A Glimmer of Hope for Emerging-Markets Stock Funds

It's Good to be Disliked
In mutual fund investing, popular children are to be shunned. As a general rule, fund categories that enjoy high net cash inflows tend to perform relatively poorly over the next several years, while those that suffer net redemptions usually fare well. This upside-down behavior is not restricted to U.S. mutual funds. Across the globe and among various asset classes, investor sentiment is a useful indicator for a security's future prospects.

Recent sentiment has not favored emerging-markets stock funds. As Russ Kinnel, Morningstar's director of mutual fund research, points out, U.S. emerging-markets funds have been bucking the usual pattern that weak performance leads to cash outflows. The category roared back from its 2008 losses with a big gain in 2009, but since then it has been treading water and has trailed pretty much all U.S. stock and bond categories. Meanwhile, cash keeps flooding in. Over the past three years, net flows into U.S. mutual funds and exchange-traded funds investing in diversified emerging-markets stocks have been nearly $140 billion, ranking the category second for inflows only behind intermediate-term bond funds (that is,  PIMCO Total Return (PTTRX)).

Russ has not been surprised, therefore, to see emerging-markets stock funds lag again this year. As he states--yes, stock prices have been getting lower, and cheaper is better than expensive, but as long as U.S. fund investors remain fond of the category, it's hard to be too enthusiastic about its prospects.

Dawn may be approaching, however. The Wall Street Journal reported a few days back (subscription required) that emerging-markets funds face an investor "exodus." Exodus is a lovely word for the sentiment investor! Unfortunately, the news wasn't quite that good. The Journal's story referred to global fund flows as opposed to just U.S.-based funds. While it's nice from the contrarian perspective to see the world's funds as a whole redeeming the category, U.S. fund investors remain more positive. Over the past week, they put slightly more money into emerging-markets mutual funds than they have redeemed. Flows into ETFs, however, were pleasingly negative.

With sentiment improving (in the perverse sense) and valuations at the point where GMO estimates that emerging-markets stocks have the highest expected seven-year returns among the asset classes, emerging-markets funds may be a timely investment.*

* Disclaimer: I don't make investment recommendations, I'm not a financial advisor, I might not have a clue, and Compliance would never want me writing such a thing. You know what I mean, though. The category interests me.

Retirement Math
The average American can expect to pay nearly $155,000 in 401(k) fees during his investment lifetime. You've seen that figure, I've seen that figure, we've all seen that figure. (If somehow you have not, Google "401(k)" and "$155,000.") However, I don't understand it.

As I've written, 401(k) plans are increasingly moving toward target-date funds, which are getting most of the assets for new investors. The average asset-weighted expense ratio for target-date funds is 0.60%. (The equal-weighted average is 1.01%, as many smaller funds with fewer assets push up that figure.) The average 401(k) balance for Fidelity's oldest age group, 55 and up, is $150,000. Make the very aggressive assumption that the typical 401(k) balance for all investors, of all ages, is that amount. (It's not.) Via the back of the envelope, the bill for a 401(k) investor holding that account for the 40 years from age 25 to age 65 would be $150,000 x 0.60% = $900 per year, times 40 years is $36,000.

I'm missing something. Or many things. I'll take a look at the study and report on what I find in a future column.

Just My Luck
Somebody came out with a study of U.S. airlines, and guess which airline fared worst? Yep, the one that I regularly fly, as I am a member of its frequent-flier program and it is based out of Chicago. United Airlines. I can't say that I am surprised. Nor, I suppose, am I shocked that the report also finds that airline quality has declined. Score me 0 for 2.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.