Fund Flows and Risk Management

As some investors move to bonds from stocks to lessen risk, others move up the risk scale to capture higher yields.

Fund Flows and Risk Management Morningstar Christine Benz: Hi I’m Christine Benz for Morningstar.com. When it comes to fund flows investors appear to be demonstrating a little bit of schizophrenia recently with some investors gravitating toward bonds and some others looking to risk the asset classes. Here to discuss the latest trends and fun flows is Kevin McDevitt he’s Editorial Director for Morningstar. Kevin thank you so much for being here. Kevin McDevitt: Thanks for having me. Christine: So Kevin I would like to discuss the ongoing trend toward bonds. It appears that we’re still seeing investor showing a strong preference for bonds over equities. Why do you think that is what are the drivers there? Kevin: Absolutely, there are a couple of drivers I think the main one is just people who are trying to kind of reduce risk in their portfolios and you’re seen on kind of two fronts one is kind of getting out of equities but then there’s also a push I should say which is not so they tied the risk it’s more tied to the lack of return on MoneyMarket funds. It’s amazing that trends we have seen since the Fed took rates to zero back in December of 2008 ever since then you saw a huge push under short term bond funds in particular so I think its on one hand again it’s risk aversion in terms of equities but then even more than that perhaps it’s money moving from money market funds into short term and intermediate term bond funds. Christine: So seeking a little bit of yield pick up whether that’s a good or right idea or not. I guess we’re not so sure about that but it’s fun more seeing. Kevin: Yes it certainly understandable but right that’s a different issue as to whether that’s the most prudent use of your assets.. Christine: Right so in terms of the risk averse group I know that you mentioned to me earlier that you think that the flash crash may have been a little bit of an inflection point for some retail investors talk about your thoughts there? Kevin: Sure well you know we had that strong rebound at great rally in 2009 and you had maybe some investors trying to kind of tip their toe back into equity funds but things really kind of turned on a dime in May, you start to see a big outflows again impart that’s due to a little flash crash. Again on that very day the market was only down about 3% which in the scheme of things is not that bad but for some reason I shouldn’t say for some reason I think there is intellectual or a psychological response to that where investors kind of felt like there was an issue of market manipulation and I think there’s somewhat of a lack of trust or a loss of trust in the equity markets so I think for some investors after what they faced in 2008, the fall of 2008 and then this on top of it the flash crash I think for a lot of investors that was kind of like the last straw I mean they said no matter what happens from here on out I’m never going to get burned that way again. Christine: So I want to talk about some of the risk your asset classes that you’ve seen investors embrace. Emerging markets is one and that is emerging markets stock funds and bond funds have seen drawing in close, can you talk about what you’re saying there? Kevin: Sure I think that’s, I think there are a couple of things happening there as you alluded to. I think one is just a desire for diversification. I think there are concerns that investors have about the strength of the U.S dollar. I think they’re worried about being locked into the US and I think also their fair move investors were perhaps under diversified. They didn’t have as much exposure you know three years ago outside of the U.S and maybe this is part of that as a reallocation. I think part of it frankly though to is also performance chasing. You’re seeing you know you’re seeing great returns of the past decade and both emerging markets stock funds and emerging market bond funds. So that’s a bit of a concern there you worry about people chasing those returns. Christine: Right, right and maybe not know the risks that are in those essay classes right now. Kevin: Right I think you’ll can get kind of caught up on this idea of emerging market growth that’s so strong and in some ways that are recovering better than the U.S economy but that doesn’t necessarily mean there won’t be volatility in those dock and bond markets. Christine: Right and it could also be well reflected in current prices too. Kevin: Absolutely. Christine: Yes, yeah right. So I want to discuss another topic Kevin. The whole category of alternatives and what you’re seeing there. It seems that there’s a lot of investor interest in those categories right? Kevin: Absolutely we get questions about those areas all the time and what’s funny though is that you’re seeing strong flows into like bear market funds, long short funds but frankly the performance has only, from what we’ve seen so far. The performance is not really there you know over the last three years SMP 500 index is down about 7% annualized but bear market funds are down and I think more than 12% annualized over that same time period in a way this is kind of the perfect test but then you had a really rough bear market. You don’t expect them to perform but that really hasn’t happened but that said the irony kind of is that you’re seeing flows into these bear market funds which have not performed entirely well and have flows out of more standard allocation funds for example like moderate allocation have seen tremendous outflows in your seen more flows into these alternative strategies. Christine: And how about in commodities and precious metals what are investors saying with their in flows and out flows from those categories? Kevin: Sure it’s kind of a similar trend to what we’re seeing in the bond side interestingly enough. You know since the end of 2008 you’ve seen huge flows into – what they were before huge flows into a commodity futures funds and some flows which were far less extent into equity precious metals funds but I think from investor’s standpoint they’re seeing zero% yields or roughly zero% yields on their money market funds so there’s not a huge opportunity cost to go in into a commodity fund for example which mine having no yield at all so I think it’s driven by the fact that again there is 0% to be earned on your money market fund but then also more broadly speaking as a concern about potential inflation tied to the fed funds rate being so low and then also concerns about the dollar itself. Christine: Okay so I would like to discuss the fun family view as well, who has been a beneficiary or some of those trends in terms of fund families and whose been seeing the outflows? Kevin: Sure we had two big winners by a mile our – and Vanguard and I think that just ties the fact that they both have these very broad, very deep bond line of—of line ups in their family so they’ve been tremendous beneficiaries of this also vanguard in a way that’s maybe not totally obvious. You know while we are seeing big outflows out of stock funds that’s not really happening with index funds and in fact we even seen in flows into index funds. Vanguard has not— Christine: Equity index funds. Kevin: Equity index funds in particular total bond market as well but on the equity side it has been fairly strong. In terms of those who are losing out the big loser here has been American funds by far. Our colleague Russ Kinnel just came out with the unloved that is the funds are just seem the biggest outflows. Those categories have seen the biggest outflows over the last year and by far the biggest categories on large value of large girls allocation and that’s American Funds. Christine: That’s their line up. Kevin: That’s their line up yeah. Christine: Right so one last question for you Kevin. I always look at this fun flow data and some people say well this is a contrarian indicator what you see in terms of mutual fund flows. Are you concerned that investors buying bonds now may get burned and have we looked at any data to support what flows portend about future performance? Kevin: Yeah I think the concern well in terms of what we’ve seen in terms of future performance. You’ve got very, very low yield to this point especially in things like tip funds treasury index inflation protected securities are seeing very low yield there and bond funds generally, but we’re also seeing two as when we talked to world allocation managers, moderate allocation managers or seeing them on the margins shifting auto bonds and into equities. I think from their standpoint they’re seeing better evaluations in many cases on the equity side versus the bond side and I think from an investor standpoint they need to be careful about where their allocating their assets in the bond side. We’re talked before kind of increasing risk appetites were seen much greater flows into margin market bond funds but also into high yield bond funds and I think investors can be careful in thinking back to 2008 how badly those funds got hit at the time and they’re concerns I think about declining credit called in the high yield market so again even though you’re seeing strong returns in those areas I think it’s going to be wary. Christine: Right, right. Well Kevin thanks so much for sharing your insights we appreciate it. Kevin: Yeah thanks for having me. Thanks for watching I’m Christine Benz for Morningstar.com.