Guided investing draining mutual funds

Last year's $226 billion worth of net outflows from mutual funds reflects a larger trend in investor behavior, according to a new research report. The industry's first full year with net outflows in 20 years reflects a general shift in distribution and ownership patterns, according to ReFlow Management LLC, which recently published a white paper on fund distribution. “Flow volatility is an ongoing trend that may not reverse even as the market recovers and net flows generally turn positive,” said Paul Schaeffer, ReFlow's president. The report says that the volatility of monthly fund flows began rising in 2006, and the increase can be traced to a “fundamental shift from direct to intermediated mutual fund investing, whether through retirement plans, financial advisers or other third parties.” According to the Investment Company Institute, just 13% of those buying funds mainly do so directly from fund companies or via discount-brokerage firms, while 51% invest mainly through an employer-sponsored retirement plan, and 36% invest through a financial adviser. Mr. Schaeffer underscored the growing influence of platforms and financial intermediaries on the increasing volatility of fund asset flows. “Not only does flow-driven trading incur significant costs without adding portfolio value, it can drive funds to market under adverse conditions, throw investment strategies off track and create unwanted capital gains distributions,” he said. According to Mr. Schaeffer, each dollar of strategy-driven trading increases portfolio value by an average of 71 cents, but each dollar of flow-driven trading lowers fund returns by an average of 86 cents. He added that flow-driven trades are estimated to account for between 30% and 40% of all fund trading. The white paper recommends that fund companies track and analyze their asset flows and related costs, examine how their distribution strategies and product mix may be affecting asset flows and explore strategies for mitigating the effects of shareholder flow on performance.