The article was published in the January 2022 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting the website.
While the S&P 500 finished with another strong year, active equity funds continue to lose market share. Outflows create challenges for managers and can alter a fund's process. Large outflows over short periods might force managers to sell the most-liquid positions to meet redemptions, which can increase the fund's exposure to illiquid securities. Conversely, selling less-liquid securities might drive down their prices and cause more damage to the fund. Longer-lasting or severe outflows could drive a parent company to liquidate or merge the fund away. More than $200 billion was pulled from actively managed equity funds in 2021.
These funds saw large outflows in 2021 as measured by percentage of assets.
After finishing in the bottom decile of the mid-value Morningstar Category in 2020, Principal Small-MidCap Dividend Income PMDAX, which has a Morningstar Analyst Rating of Bronze, suffered as investors pulled $817 million from the now $1.2 billion fund in 2021. Much of that was from a large institutional client’s withdrawal, right around the time (March 2021) one of the team's veteran managers retired. With little cash on the books, the managers trimmed about 40% of each holding in March to account for the redemption. While the portfolio's overall composition (in terms of total holdings and sector exposure) has remained largely unchanged, another sizable redemption could pose challenges. Assets also fell through a fee breakpoint, making it more expensive for investors.
Before 2021, Bronze-rated Causeway Emerging Markets CEMVX endured two years of over $500 million in outflows. That trend continued in 2021, as the fund lost more than $1.4 billion in assets, or about 40% of its assets from the beginning of year. The veteran managers run a blended quantitative approach that uses a bottom-up fundamental model with a top-down model. The strategy finished in the bottom half of the diversified emerging-markets category for the four years through 2021 as quantitative strategies generally struggled. The good news is that the strategy typically sticks to liquid, large-cap companies, but having a large stake in China raises the risk of economic, political, or regulatory turmoil.
After seeing significant outflows in 2020, Bronze-rated Meridian Small Cap Growth MISGX lost 36% of its assets under management in 2021, partly because of poor performance in 2019 and 2020. Outflows have affected the portfolio. The fund has often kept a decent cash balance on hand, but that has been cut down significantly since early 2020, likely as the managers tapped it to meet redemptions. The portfolio's micro-cap weighting has grown, too, from 23% of assets in 2019 to around 35% in late 2021. Micro-cap stocks are among the least liquid, so it might prove difficult for the fund's managers to handle continued outflows. Investors in taxable accounts also face capital gains exposure, as the outflows contributed to a 23% capital gains distribution in 2021.
Bronze-rated Virtus Vontobel Emerging Markets Opportunities HEMZX has had trouble gaining its footing since its longtime manager Rajiv Jain departed in 2016. While Jain’s new firm, GQG Partners, has steadily accumulated assets, this fund has seen continued outflows since the beginning of 2018, thanks in part to bottom-half finishes in the diversified emerging-markets category in 2019 and 2020. It lost almost 35% of its assets from the start of 2021. This strategy invests in some relatively liquid, large-cap companies, but it had 56% of assets invested in emerging-Asia markets in December 2021. China is not the most liquid market and tends to have big swings, so the fund is in an unusually risky place right now. Strong outflows also contributed to a 16% capital gains distribution in 2021.