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A Great Year for Fund Performance

Russel Kinnel
Christine Benz

Christine Benz: Hi, I'm Christine Benz for The market has lifted nearly every mutual fund in 2017. Joining me to discuss performance trends and other trends in the mutual fund world is Russ Kinnel. He is director of manager research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Glad to be here.

Benz: Russ, let's discuss performance. As I said at the outset, it's been a really good year, but let's talk about some of the categories that have been the best performers and some categories that haven't performed quite so well in 2017.

Kinnel: As you said, it's been a great year. Almost impossible to lose money in funds, which is kind of funny. I wouldn't have necessarily predicted such a great year.

Benz: Me neither.

Kinnel: But U.S. equities, foreign equities, fixed income--just about everything did really well, except maybe energy. A tremendous year. Best place to be was in that upper right-hand corner--large growth, both foreign and U.S., was the best place to be. Returns around 28% as we speak near the end of the year.

Benz: For large growth.

Kinnel: For large growth. Obviously, the FAANGs, social media, other tech companies, overseas you had some of the Chinese companies doing a lot like what Facebook and others were doing here. Tremendous growth in that large growth segment. But other areas did pretty well, too. It was kind of a really strong year across the board. Small value was the one sort of weak link. It returned around 8%. Right now, that's about less than one third of what large growth did. Very much a growth market, larger better than small.

Benz: Are you hearing from fund managers--I know you and the team are frequently in touch with managers who have latitude to invest in various pockets of the market--do they think that value is cheap right now?

Kinnel: Yeah, I definitely get that sense that there's a little more enthusiasm for value. But at the same time, you also get the sense that there's increasing pressure, because if you lean too heavily to value, especially away from tech, you probably had a couple of difficult years and you may be feeling pressures. Yes, I think managers do feel, in general, we are hearing more interest in value, but at the same time the growth in the Internet-related stocks and some other tech names has been tremendous, and that's alluring, too.

Benz: You mentioned fixed income performing decently despite the fact that the Fed has been deliberately but nonetheless raising rates. What have been the best pockets to be in the bond space?

Kinnel: Foreign bonds have done well. High-yield has done well. Munis have done pretty well considering all we heard about the negative news about Puerto Rico. Again, pretty strong across the board. Naturally, some of the more conservative areas like TIPS are more modest returns. We didn't have as much dispersion as we saw on equities. A lot of returns clumped between, say, 3% to 7% in the bond world.

Benz: It's safe to say that in fixed income as well as in equity investors have been in risk-on mode, where they have been comfy taking credit risk especially?

Kinnel: Most definitely. Credit risk and just about any other kind of risk. Emerging markets had a tremendous year. We are really seeing risk is paying off. I think, in a way, it's just sort of investors have nowhere else to go. They are staying in equities. So far, it's been paying off. Interest rates are still low, so there's a lot of leverage out there. People can borrow to invest and that often has the effect of pumping up markets, too.

Benz: Let's discuss fund flows. I know you keep an eye on fund flows, and one of the major trends really over the past decade is this phenomenal flow of assets out of active products into passively managed funds. But active funds did have positive inflows for 2017. Let's talk about what's going on there.

Kinnel: That's right. Massive swing continuing to passive versus active. Within active, it's mostly U.S. equity that's shedding assets. Outside of U.S. equity, investors are still interested in active. Fixed income, foreign equity, allocation, both munis and taxable within fixed income, we're still seeing solid flows. Intermediate bond is one of the best-selling areas of the fund world overall and nearly all of that's going into actively managed money.

Benz: iInvestors haven't totally given up on active managers in certain areas?

Kinnel: That's right.

Benz: Looking forward into 2018, what are the key trends that you think will prevail? Do you think that this trend into passive will continue? What are the other things you expect to see shake out next year?

Kinnel: The continuing trend to passive is probably the best bet of all. 

Benz: It's been hard to go wrong with that one.

Kinnel: That one has just been steady and I'm pretty confident that's going to continue. After that, of course, it gets really murky. I think there's definitely a lot of change. On the one hand, we've got this new tax bill that's about to be passed as we speak and that's going to change things tremendously. One of the things to look for there is, corporations are estimated to be getting about a 10% windfall from this. Most analysts say it's going to return to shareholders via dividends and buybacks, which would suggest you want to own maybe an equity income fund. But if that actually plays out, it's going to be something worth watching.

Another thing that's interesting is, there's going to be dramatic change at the Federal Reserve. Not just the chairman, but a lot of key positions at the Fed are turning over in this coming year. It's really going to be a little unnerving, I think, for the markets. Markets like really steady-as-you-go, predictable behavior from the Federal Reserve. With a bunch of new players coming on, I don't think that will be the case. That's another thing, I think, that's going to really roil the markets and have people watching closely.

Benz: We've certainly all gotten really spoiled with very low volatility and great returns in 2017.

Kinnel: That's right. It's hard to imagine it can continue as well as it's been. But it's a good reminder too that, one, markets are unpredictable, and two, you really can't afford to miss years like 2017 because they are so important to reaching your goals.

Benz: Russ, thank you so much for being here to share your insights.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for