Funds with cyclical and high-yield exposure have had a rough start to 2016 as investors seek stability, but target-date funds should continue to improve investor returns.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The year 2016 has gotten off to a volatile start. Joining me to provide a recap of what's been going on in various asset classes are Janet Yang, she is head of multiasset manager research at Morningstar, and Sarah Bush, who is head of fixed-income manager research at Morningstar.
Sarah and Janet, thank you so much for being here.
Sarah Bush: Thanks for having us.
Janet Yang: Thanks a lot.
Benz: Janet, let's start with you and talk about the equity market. When you look across the various equity categories that the manager-research team covers, what trends do you see?
Yang: Well, I think you see basically a move to quality. When there's this kind of volatility, you just see investors wanting more stability. So, that means larger-cap funds and stocks have been doing better than the smaller-cap ones. Within those sectors, you see any funds with energy, commodities, or even biotech--which was a big surprise this year--not doing very well. Then, when you look overall, value emerging-markets stocks and funds really have been hit the hardest.
Benz: Would you say things that have sort of a cyclical tilt to them have been the hardest hit--some of the economically dependent parts of the markets?
Yang: Right, absolutely. Anything that is linked to China, for example, has been hit pretty hard. Again, that's natural-resources stocks and funds, for example.
Benz: So, in a way, some of those categories had been hard-hit in 2015, and this is really a continuation of that. But biotech, that's fairly new. Biotech was a great-performing sector in the recent past.
Yang: Exactly. 2015 was a great year for them. Maybe it's just a case of what has risen the highest falls the farthest.
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Benz: Sarah, let's turn it over to the fixed-income markets. Have fixed-income investments provided good ballast amid all of this equity-market volatility?
Bush: Yeah, the core funds--the intermediate-term bond category and also the Barclays U.S. Aggregate Bond Index, which a broad-based investment-grade index--have kind of been performing as you'd want them to and providing good diversification. They are up modestly year to date.
Benz: I know that junk bonds have been an area, though, that has been under a little bit of a cloud. Has that continued so far this year?
Bush: Yeah, that's a continuation of the story that we saw in 2015. We saw losses of about 4% in the high-yield bond category. That has continued. I think the category is down somewhere around 1%, and the story there has continued to be that the energy and other commodities-related sectors have been the hardest hit. So, funds with large allocation to those have done poorly. Some of the intermediate-term bond funds with more high-yield exposure have also had a little bit of a rough time. So, that really is a continuation of what we saw in 2015.
Benz: We looked at fund flows recently. It looked like investors were continuing to pull their money from high-yield funds.
Bush: Right. And that's actually interesting because we had a manager in earlier this week who was talking about it being a pretty good buying opportunity. I think everyone is expecting defaults in some of the commodities-related sectors; but outside of that, people are starting to talk about some opportunities. But there are a lot of things that could continue to cause headaches for high-yield investors in the short term.
Benz: As we often see in these types of markets, certain types of bonds have performed really well.
Bush: Yeah, as you'd expect, long-term Treasuries have been at the top of the heap. They've done really well. And then this is, again, a risk-off environment, so in addition to high yield having some difficulties, emerging-markets bonds have also had a little bit of a rough time. I won't overstate it, but they've had a little bit of a rough beginning to the year.
Benz: Janet, your team focuses on funds that put bonds and stocks and other asset classes together. Let's talk about some of the performance patterns that you see when you look across these categories that are classified as multiasset.
Yang: So, given what you see in equities versus fixed income, basically you see a pattern that you'd expect. Funds with more equities have done worse than funds with less equity. So, if you take a look at conservative-, moderate-, and aggressive-allocation funds, you see a nice stair step. Basically, conservative funds have held up the best, and the aggressive funds have lost the most.
Benz: Then, you also oversee the coverage of the target-date fund universe, which is really growing in importance--certainly, in retirement plans. If investors have target funds, what performance patterns are they likely to see?
Yang: They have performed exactly as you'd expect. The funds for the youngest investors--for 20-year-olds--have lost about 7% or 8% versus [the funds for those] closest to retirement, which have lost about 2% to 3%. So, the losses aren't ideal, but at least they are kind of performing as you would expect. I think, with target-date funds, they are actually kind of instructive with what investors should maybe do in this kind of environment.
We've looked at investor returns for target-date funds. This basically takes into account cash flows into and out of the fund, so you get what the investor actually experienced versus the total return--the published return. So, with target-date funds, we actually found that investors had better results than other investor returns for other funds. Basically, for other funds, you see a systematic result where investors are buying high and selling low. That's not ideal.
But with target-date funds, because they were putting in money steadily, they had actually better investor returns than the total returns. There is nothing magical about target-date funds. It's just that because they're in retirement funds, they have that automatic weekly or biweekly investment. And because those investors kind of stayed the course, they ended up benefiting from rebounds. So, in these times of market volatility, I think that stay-the-course advice is good.
Benz: Do you think target-date funds have also had an advantage in that they step up and do some rebalancing, whereas individual investors might not feel like, say, being a buyer in a time of market volatility?
Yang: Right--absolutely. It doesn't feel good to buy equities and to rebalance back to equities when equities have dropped this much. Target-date funds basically have that built-in discipline, and so that's worked to investors' advantage.
Benz: Sarah and Janet, thank you so much for being here to share your insights. And thanks for watching, I'm Christine Benz for Morningstar.com.
