Christine Benz: Hi, I'm Christine Benz for Morningstar. International-equity funds were the biggest beneficiaries of new investor dollars in the month of March. Joining me to discuss this and other news in the world of fund flows is Tim Strauts. He is a senior markets research analyst with Morningstar.
Tim, thank you so much for being here.
Tim Strauts: Thanks for having me.
Benz: So, these big flows into international-equity funds--this is really part of a trend that we've been seeing for some time, correct?
Strauts: Yes. Last month, there was $34 billion in flows; but since 2007, international equity has taken in a cumulative $700 billion in flows and U.S. equity has taken in zero. So, investors have clearly been moving to international funds over the last several years.
Benz: So, I'm sure there are a lot of factors driving this, but is rebalancing perhaps part of the reason or can you conjecture about the rationales for that?
Strauts: I think, in general, investors have been scared away from the U.S. equity market; mind you, this number is from 2007. Since then, U.S. stocks have actually done very well, which is kind of surprising. You'd think that investors would be performance-chasing U.S. stocks, but they are not. They seem to have been scared off from the experience of 2008, and they've been looking to other regions like emerging markets for growth, which actually haven't performed that well recently.
Benz: That's right. So, that's what I want to look into. In terms of international equities, it's a broad basket of funds. Let's talk about the types of products. When you look at where the flows are going, what are investors buying?
Strauts: Investors are buying the hedged equity funds, which are relatively new products. Traditionally, investors have bought international funds on an unhedged basis, meaning that you own the stocks, but then if the currency moves, the currency can either subtract or add to your performance. But since the moves in the euro, where the euro has fallen dramatically versus the dollar, a lot of investors have been piling into these hedged funds.
Benz: So, investors are assuming that the dollar will continue to be strong relative to other foreign currencies. Is there an element of performance-chasing here? Because when you look at, say, Europe, the markets have performed really well; it's the euro that hasn't performed well versus the dollar.
Strauts: Yes, there is definitely performance-chasing. An example would be WisdomTree Europe Hedged Equity (HEDJ), which is the largest-flowing fund in this space; over the past 12 months, the fund has returned 24%. But if you compare that with the unhedged MSCI Europe Index, it actually outperformed that index by 28%, which tells us that MSCI Europe actually went down with the effects of currency. So, it's a huge difference for investors. I'm a little bit scared for investors piling into these funds today because they seem a little bit late to the party.
Benz: And when you look at the valuations of European stocks, they're maybe not all that cheap. Even though Europe obviously has a lot of problems, the stocks have enjoyed a really good runup, as you say.
Strauts: The ECB's quantitative-easing program has, I guess, been a resounding success if they were looking to boost the stock markets--because their stock markets have taken off. Their economies and some of the financial numbers haven't necessarily started to improve yet, which may happen in the future. But the stocks have taken off, and they're really not the cheap valuations we saw a year ago.
Benz: Looking to U.S. equities, the story is a familiar one where we continue to see investors show a strong preference for passive products there and [we're seeing] money coming out of the actively managed funds.
Strauts: It's a continual story. It's almost every month. Another $15 billion flowed out of active U.S. equity and $9.5 billion flowed into passive. So, this is the same story we've talked about in the past.
Benz: In terms of taxable bond, that's an interesting one. We saw decent inflows into taxable-bond funds in the month of March. What types of products are investors buying there?
Strauts: There was a $12.5 billion inflow in March. The money was really focused on intermediate-term bond, because long government and high-yield bond were in outflow. So, investors seem to be looking to the core bond funds. Just last month, they actually were focusing on an active core bond funds, because intermediate-term bond took in $9 billion in assets on the active side and only $3.6 billion on the passive side.
Benz: So, it seems like even though they're buying these core bond funds, they are doing some repositioning. Investors are continuing to swap out of PIMCO Total Return (PTTRX)--though the outflows have slowed down a little bit--and they're swapping into other funds. Let's talk about the PIMCO story. It did have outflows in March, but they do appear to have cooled off a little bit.
Strauts: Yeah, the outflows were negative $7.7 billion, which is a very large outflow for any other fund, but it's actually the smallest outflow since Bill Gross left the firm. So, the pattern is getting better. In December it was negative $18 billion, and in January it was negative $12 billion, and in February it was negative $9 billion, and now it's negative $7 billion. So, things are getting better. How long is it going to take before the outflows stop? Who knows?
Benz: I guess a lot of it will hinge on how they perform. Let's talk about what investors are buying. They're sticking with taxable bond but maybe getting out of PIMCO Total Return. What funds have been the biggest beneficiaries? I know [MetWest Total Return Bond (MWTRX)] had been one that we've been watching. They've been a pretty big beneficiary of new cash.
Strauts: Yes, MetWest Bond has been in the top five flowing funds for the last six months. Other funds like Dodge & Cox Income (DODIX) fell out of the top five this month, but it still took in, I think, a little over $1 billion. So, those are the two big primary beneficiaries. The other one always is Vanguard Total Bond Market (VBMFX), the passive fund. That always gets strong inflows.
Benz: So, it's not necessarily a clear preference for active there. Investors have, in fact, been buying a lot of passive fixed income as well.
Strauts: I think most investors coming out of PIMCO Total Return are probably going to an active fund, but some of them are also looking at the passive side.
Benz: I want to discuss briefly one sector category that showed up in terms of having some of the biggest inflows recently. It's the healthcare sector. We've seen such strong performance. Anytime I see this combination, I get a little worried. What's going on there? Is it investors perhaps just doing a little performance-chasing?
Strauts: There is definitely a performance-chasing aspect. Healthcare, traditionally, was thought of as a defensive sector; but now with biotechs being such strong performers, those are much growthier names. The healthcare sector is a lot more of a growth sector. So, it's not the defensive sector of old. So, I think definitely investors are performance-chasing. As far as where valuations are now, it's definitely not a cheap sector. Returns in some of these biotechs are, over the past two years, in some cases, over 100%. So, it's really an incredible performance.
Benz: So, buyer beware maybe if you're getting there just now. Let's take a look at fund families. We have continued to see the Vanguard juggernaut chug ahead, but let's also discuss Fidelity, because I think it's kind of a switch, at least in the month of March, where we saw pretty good inflows into its actively managed equity funds.
Strauts: Yeah, they took in $6.5 billion as a total for the firm. It was actually not any one fund. It was kind of spread around the whole lineup. So, that's a good sign. If you have all the money flowing into one fund, that can signal hot money; but when it's moving throughout the entire firm, the money is likely to stay there longer. Also, I would note that there was a big story on the new CEO--
Benz: Abby Johnson.
Strauts: Yes, Abby Johnson. So, I don't know if that maybe got them some publicity and maybe people looked at Fidelity funds again this month. That's hard to say.
Benz: We'll be keeping an eye on it. Tim, thank you so much for being here. It's always great to hear about what investors are doing. It's always fascinating to hear about where they're making their choices.
Strauts: Thanks for having me.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.