After a Strong Start to Year, U.S. Fund Flows Take a Dive

This is an excerpt from the Morningstar Direct U.S. Fund Flows Commentary for May 2019. The full report can be downloaded here.

U.S. fund flows were weak across the board in May, halting a string of strong months to start 2019. Investors pulled nearly $2 billion from long-term funds (open-end and exchange traded funds) in the worst month since outflows spiked to $91 billion during last December's market turmoil. Perhaps spurred by declining equity markets, investors turned cautious. (The average U.S. large-blend equity fund dropped 6.3% in May.) Money market funds were the primary beneficiaries, collecting about $82 billion as investors fled to safety. It was the group's best showing since last November's $84 billion haul and the second-best over the past 10 years.

Somewhat atypically in recent times, investors lost their taste for equities as markets declined. U.S. equity funds lost about $15.6 billion to outflows in May. By contrast, during 2018's fourth-quarter correction when the typical large-blend fund fell 13.6%, U.S. equity funds took in about $52 billion and had positive flows all three months. Our assumption was that the correction actually drove inflows as target-date funds and other managed portfolios were forced to add to their U.S. equity positions in order to keep them in line with their target allocations.

As to why this dynamic didn't play out in May, one fund played an outsize role. SPDR S&P 500 ETF SPY absorbed a $16.6 billion slug of outflows, its worst month since losing $19.6 billion in February 2018. In this fund's case, its outflows since the latter date may be more structural than market-related. The fund's 0.09% expense ratio is higher than several prominent passive rivals, and it hasn't tracked the S&P 500 as well, either, owing to limitations in its use of futures contracts. Overall, passive U.S. equity funds saw $2.7 billion in May outflows.

Meanwhile, active U.S. equity funds endured $12.9 billion in outflows, which was in line with recent trends. Overall, active U.S. equity funds finished May with about $89 billion more in assets than passive U.S. equity funds, $4,082 billion versus $3,993 billion. Recall that last month we wrote that passive U.S. equity funds were about to overtake active U.S. stock funds in assets, with only $6 billion separating the two groups. While the trends are still intact, an issue with how we collect the data resulted in the early call on parity.

For the sake of timeliness, we publish the monthly flows data when we have at least 99.5% of funds reporting. This 0.5% gap means that numbers will change as additional funds report their assets. So, the asset and flows data often change after we report preliminary numbers. The changes are usually at the margins, but last month, active U.S. equity fund assets increased by more than $100 billion after we published our report, an exceptionally large difference based on past history.

Other trends for the month of May included:

• Taxable-bond inflows fell dramatically in May to $15.4 billion, the group's worst showing year to date. Credit-oriented high-yield bond and bank-loan funds fared worst, losing $5.8 billion and $3.1 billion, respectively, to outflows.
• Vanguard led all families with $16.7 billion in inflows, followed by $5.1 billion from Fidelity; iShares' flows were flat. State Street Global Advisors, at the other end of the spectrum, was hit hard by $22.6 billion in outflows, followed by Invesco's $5.8 billion in outflows.