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Odd Mix in Fund Flows This Year

Russel Kinnel
Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. What do fund flows say about investor sentiment? Joining me to discuss the year's biggest asset gatherers and losers 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 some of the top categories in terms of inflows, and this encompasses both exchange-traded funds and traditional mutual funds. It's kind of an odd group as you portray it. Foreign large blend, intermediate-term bond, and ultrashort bond. Are there any commonalities among these?

Kinnel: It is an odd mix. Usually, you see a distinct theme. Everyone is going at equities or bonds or one area. I do think there are a couple of themes. I think the first theme is passive. Foreign large blend, of course, if you're buying a foreign index fund, that's going to be a category, but also people like active foreign equity as well. Then intermediate bond, again, there's a big passive component to that. 

I think another reason you see intermediate bond and ultrashort bond is interest rates have been rising. Inflation expectations have grown. Interest rates are rising. Obviously, it means in the short term there's some pain because that means bond prices are hurt to adjust for that, but it does mean there's a lot more yield in intermediate bond and ultrashort bond whereas two or three years ago, a lot of the categories outside of high-yield had very low yields and were not very appealing. I think as yields have grown, investors are coming back.

Benz: In terms of the top categories in terms of outflows, where investors have been pulling dollars, kind of an odd group again. Large value, I guess, that one is maybe obvious given that we've had underperformance in value stocks; high yield, and large growth. Let's talk about those.

Kinnel: As you say, large value--one, we know value is underperforming because FAANG stocks are where it's been at for the most part. But again, I think another part of it is people putting money into core equity index funds, so that means large blend, and they are selling their large value and large growth which are predominantly active funds to buy in. As we've touched on before, it's not that dramatic a move, if you, say, sell a large-growth and large-value fund and then you buy a total market index fund, you really aren't changing your overall exposure very much. That's a big part of it for sure. 

Then I think high yield, maybe people are scared that there have been some sell-offs in high-yield and also just you can now get decent yields from lower risk funds.

Benz: The headline when we look across categories is that U.S. equity has had inflows year to date, but they have been pretty tepid. Meanwhile, taxable bonds have been seeing $170 billion in inflows. This despite the fact that the U.S. market has performed really quite well so far in 2018.

Kinnel: That's right. The old model for predicting flows is you look at the last few years and whatever is the best returns explains that. But obviously, that's not the case at all, because equity returns have been far better than bond returns, but all the money is going into bonds. This almost looks like the year after a bear market. I think a lot of it is a movement into higher yielding bonds, because again, as I mentioned, bonds have a nice yield for a change. You may see money that's coming out of CDs and money markets because now intermediate bond funds and some other kinds like that are now paying a decent yield, though obviously even CDs and money markets have a better yield than they used to. Then equities, I guess, there's just a wariness. We can blame some of it on active/passive when earlier, but you can't blame the aggregate obviously, right?

Benz: Right.

Kinnel: It's really an interesting move and I think we really have to watch it closely.

Benz: In terms of the specific funds getting the biggest inflows, one interesting data point that you noticed was that just four of those in the top 20 are active. You've mentioned the stampede that we've seen to index products. Let's talk about those active products that have been getting new money. Toward the top of the list, PIMCO Income, Lord Abbett Ultra Short Bond, PGIM Total Return Bond. What's the attraction among those funds? Or what's the commonality, if any?

Kinnel: I think really strong performances. Maybe at an allocation level, people aren't chasing returns, but within categories, maybe they are. These funds have all had very strong performance, better yields than their peers, and I think people are responding to that. 

To me, it looks like a little changing of the guard versus a few years ago, if you looked at the funds that brought in a ton of money when Bill Gross left PIMCO …

Benz: The fixed-income funds.

Kinnel: Right. Some of those are not on this list, some are even in outflows, funds like DoubleLine Total Return, MetWest. Really, it seems like we've got a bit of a changing of the guard.

Benz: In terms of active bond funds?

Kinnel: In terms of active bond funds. Yes.

Benz: Okay. At the fund family level, in terms of inflows, this won't be a surprise to anyone who has seen us cover flows before, Vanguard has seen the most in terms of new inflows in 2018. Fidelity, you note though is interesting on this list, in part because so many of its new inflows are coming from passive products.

Kinnel: That's right. Fidelity came out with the zero fee index funds and they have been big sellers. In a sort of unusual twist now, Fidelity is third on our list of biggest selling fund companies, and passive is a big part of it.

Benz: And historically, the Fidelity story has been an active story?

Kinnel: Historically, an active story, historically, a place they used to really have a lot of disdain for index funds, and now here they are leading the way on index funds. At least credit for being open to new ideas and coming up with competitive products for investors' demand.

Benz: Right. Because Fidelity does have some very good index products.

Kinnel: Yeah.

Benz: Let's talk about the outflows. Franklin Templeton is toward the top of the list. You say that really a lot of the key ingredients in Franklin Templeton's lineup just aren't in market favor right now.

Kinnel: That's right. If you look at their equity funds, there's a strong value tilt to both Templeton and mutual series legacy funds. They do have some growth exposure. Really, Franklin Templeton leans toward the value side. And then in fixed income, you've got Michael Hasenstab's funds which are pretty aggressive emerging-markets-leaning funds, and emerging-markets debt has had trouble; Argentina, for instance has been in the news a lot. They have had some challenges there. Really a lot of things are working against Franklin Templeton and they don't have much on the passive side. Again, kind of in the wrong spot at the moment on a lot of different places.

Benz: Russ, interesting insights. Thank you so much for being here.

Kinnel: You're welcome.

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

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