Big shake-ups for mutual funds

Dec 10, 2013 @ 12:00 am

Runtime: 5:36

Massive outflows from bond funds and actively managed funds mean big market changes. Two veteran Morningstar analysts discuss what these shifts mean for returns.

Video Transcript

This week on WealthTrack, big shake-ups in the mutual fund industry. Two veteran Morningstar analysts, Christine Benz and Russ Kinnel, discuss the massive outflows from bond funds into other investments and from actively managed funds into passive ones. What do these shifts mean for portfolio returns? Morningstar's dynamic duo is next on Consuelo Mack WealthTrack. I began the interview by asking them to name the biggest unintended consequences of the huge shift from actively managed to passive funds. -Well, as we've seen flows come out of active funds into passive products, what that has necessitated is that some fund managers are having to sell stuff-- -Right. -to meet the shareholder redemptions and that can cause them to have to realize capital gains to sell securities that they might, otherwise, wanna hang onto. And so, what we're kind of bracing ourselves for, because we have had a five-year equity market rally as well, is that we could see funds making bigger than average distributions this year (a) because they're meeting these redemptions and, (b), because they simply have big capital gains on their books. -So, what does that do, Russ, to the funds' performance themselves if they are basically being forced to maybe sell securities that they didn't necessarily wanna sell and make their portfolio smaller? What's the impact on their performance?-Yeah. If you-- If you get redemptions to a critical level, say, 20%, 30%, 40% of assets, it can have a negative effect where the manager has to sell and maybe have to sell at lower prices than they want. That hurts performance. People redeem more, and so you have this negative cycle. Now, there's a positive side if maybe redemptions are a little lighter or maybe flows are very mild. It can mean the fund still has enough flexibility to invest well. Usually, five years into a bare-- bull market, it's a-- lots of funds are overloaded with assets. This time, there are still some good active funds out there that people have still overlooked five years in, and that's a good part of it. -Do you-- Do you have a couple that you might wanna mention to us? -Sure. So, I think there's some re-forgotten funds, funds that we knew once and have kind of lost interest in. So, for instance, the Longleaf Partners is a very good, old-school, deep-value focused strategy. -Was that closed at one point? -It has been closed. -Right. Is it open now? Longleaf? -Yeah, it's open. -Okay. -They have-- They have a small-cap fund that's closed, but the Longleaf Partners Fund is open, and they're very careful about not taking in too much money or not taking money when the market looks overheated. So, they're just a really good, old-school-- -Right. -active manager. -Should I be looking more closely at my portfolio and saying, you know, "Where am I gonna get hit by these capital gains?" -I think you should,-- -Yeah. -and the nice thing is, is that most fund companies will print preliminary lists of distributions, so you wanna be on your guard, especially if you had maybe planned to lighten up on something anyway. It's probably a good reason to get in there and do your selling before the fund makes its distribution rather than wait until afterwards, but I usually say, "Don't try to get too fancy in terms of timing these distributions." If you did not wanna sell something in the first place, a capital gains distribution, provided it's, say, under 10% of the net asset value, shouldn't be an impetus to preemptively sell. -All right. So, where do you two come out in this active versus passive debate? -You know, I think one thing active managers really can do better than most passive is they can moderate risk. You don't-- We always think about performance, but an active manager can go into more stable stocks. They can build cash. They can, you know, maybe even have some shorts. But there's a lot of good things that, if you look at it on the risk-adjusted side, active managers can add a lot of value. So, I think more so than an asset class, I think about lowering risk, but there are asset classes. For instance, muni bonds is one where indexing doesn't really work and there are some really good muni managers. Vanguard's funds are only slightly active, but they are active. -Uh-huh. -Fidelity is a great muni manager as well. We really like their funds. -So, you don't wanna just have an index fund of muni bonds. You wanna have somebody selecting them. -That's right. You don't want all of those credit risks just taken blindly. -Right. So, Christine, are there better asset classes to be in active versus passive, for instance, and vice versa? -I think when we run the data on this issue, we tend to see it ebb and flow, and so at certain points in time, active management will look very good, other times less good. I really like your point about life stage, though, because I do think that, for people who are retired and certainly in the later retirement, the idea of using an indexed portfolio, a very skinnied-down list of holdings, I think, can be really helpful. It gives the person less oversight. I talk to a lot of seniors who maybe are looking at a spouse who is not engaged in investing. The all-index portfolio can enable them to have a very small list of holdings that the spouse could more readily come in and get his or her arms around if need be. So, I do like indexing, particularly, for people who are maybe in their later retirement years.


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