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Editor’s Note »
The flow of investment dollars in and out of equity mutual funds has historically been correlated with the performance of the stock market. Bull markets historically have prompted investors to move money into equity mutual funds; bear markets have prompted them to pull money out.
This pattern has been showing signs of breaking.
Consider what happened last year. Investors collectively pulled $156.5 billion from stock-oriented mutual funds in 2017 according to data from the Investment Company Institute (ICI). Actually, they were withdrawing their dollars from domestic equity mutual funds. Domestic equity funds incurred cumulative outflows of $231.8 billion last year. This large amount of outflows occurred despite a 21.8% total return for the S&P 500 index and an 18.9% total return for the equal-weighted S&P 500.
Where did the money go? It’s not a question with a straightforward answer, but the data does give us some clues.
Global equity mutual funds realized inflows of $75.3 billion. In other words, while individual investors were leaving domestic equity funds, some were rotating into international equity funds. One possible reason may have been the outperformance of the foreign markets. All of the international indexes listed here of our annual Guide to the Top Mutual Funds outperformed all of the domestic stock indexes last year.
Bond mutual funds attracted nearly $258 billion of new money last year. This is not a typo; it’s an ongoing trend I’ve seen in the weekly fund flow data that the ICI publishes. Most of the inflows have gone to investment-grade taxable bond funds, even though yields remain low and the Federal Reserve is in a tightening cycle.
Target date funds continue to grow. Last November, Vanguard said half of the participants in a workplace retirement plan run through Vanguard were invested in a single target date fund. While 43% of 401(k) and similar plan participants were automatically enrolled into a target date fund, 55% voluntarily chose a target date fund.
Then there are exchange-traded funds (ETFs). Net issuance of ETFs totaled $477.8 billion dollars: $351.6 billion for equity funds and $121.4 billion for bond funds. Year-over-year growth was stronger for equity-focused ETFs than it was for bond-focused ETFs.
Notice the word “issuance.” Whereas the purchase or sale of a mutual fund causes money to flow into or out of its pool of assets, ETFs are different. The purchase or sale of an ETF on the open market is a transaction between two investors. The transaction, by itself, does not alter how much money the ETF manager has to invest. Rather, the pool of assets is only altered when institutional investors (including large trading firms) purchase or redeem creation units (blocks of 50,000 shares or more) from the ETF provider. This difference makes it hard to determine how much of ETF flows reflects the actions of individual investors and how much reflects the actions of institutional investors. (Mutual funds predominantly manage individual investor money.)
One trend at play is the growing popularity of indexing. Index funds continue to attract more flows and are driving costs lower. You can see this in our Guide. Among large-cap domestic funds listed in both this year’s and last year’s print edition (a subset of all large-cap funds), the index funds experienced stronger growth in assets under management . AUM increased by $383.9 billion for the 23 large-cap index funds included in the 2018 and 2017 Guides. For the 92 actively managed large-cap funds included in both this and last year’s Guides, AUM increased by $170.4 billion. Median expense ratios declined for both groups: 0.18% versus 0.22% for the indexers and 0.71% versus 0.76% for the actives. Even if you don’t index, you’re likely still benefiting from the lower expense ratios.
Whichever fund you chose—mutual or exchange-traded, index or active—start with your long-term allocation strategy first and then choose the right fund for your portfolio. Look at long-term performance, cost, turnover and tax efficiency.
Wishing you prosperity,
Charles Rotblut, CFA
Editor, AAII Journal