Why 2013 mutual fund flow trends should continue

Investors shouldn't make too much of positive bond inflows in January, an analyst warns
FEB 07, 2014
We suspect that net cash outflows from bond mutual funds — a trend firmly established in mid-2013 — will continue in 2014. Don't read too much into the positive net cash flows that flowed into bond mutual funds during the first two weeks of January. After all, these were the first net inflows to this fund category since the end of September 2013 — and are especially unsurprising, as bond mutual fund flows tend to spike during January. For example, the first week of 2013 was the highest weekly net cash flow into bond funds recorded across the entire year, and for the whole month, more than $32 billion in net inflows came in. In fact, for the past three decades, January has brought in more net cash flows (cumulatively and on average) than any other month. Heading into February, our expectations are already coming to fruition as a third week of estimated new cash outflows has brought the year-to-date tally back to negative territory (estimated $0.6 billion). Since June 2013, worries over rising interest rates and the Fed's next moves coincided with an average of more than $22 billion a month flowing out of this large fund category, totaling $177 billion in net cash outflows. This trend led to the first annual net cash outflow in nine years for the category. Despite this outflow, aggregate net cash inflows from 2007 through 2013 for this broad category remain at a whopping $1.1 trillion; 95% of this accumulated from 2009-2012. U.S.-focused equity mutual funds: Slightly positive YTD — but still a big shift Despite the recent decline in U.S. equities, net cash flow estimates into domestic equity mutual funds are holding in positive territory so far in 2014 (at an estimated $8 billion). Last year's net inflow of just over $20 billion was but a drop in the bucket compared with a fund category that measures at more than $5.7 trillion in assets. Still, after seven consecutive years of annual net outflows from the category (totaling $623 billion), last year's net inflow was surely a sign of a changing tide … especially compared with 2012's $153 billion net outflow, which was the largest annual nominal net outflow ever recorded for this giant fund category. While we don't expect cash to gush into this particular fund category on a net basis (as U.S. investors remain flush in U.S. equity mutual fund holdings), we do expect that equity funds in general will be favored over bond funds. Foreign-focused equity mutual funds: 2013's star category continues raking in cash Foreign-focus equity mutual funds continue to record impressive net cash inflows so far in 2014, with nearly $20 billion estimated in net inflows through early-February. This was the most popular fund category in 2013 as measured by net cash flows, ending the year at $143 billion; these nominal flows are on par with levels seen in the foreign mutual fund heydays of 2006 and 2007. Assets under management for this fund genre have now eclipsed that of 2007, nearly reaching the $2 trillion mark at the end of 2013 ($1.98 trillion). Hybrid funds: Blowing away prior records Hybrid mutual funds (defined by ICI as asset allocation, flexible, income mixed and balanced funds, but not to be confused with funds of funds) continue gathering assets at an extraordinary clip. This trend is not slowing in 2014 either, as an estimated $9 billion in net cash inflows have already been recorded (on par with levels seen through early February 2013). Last year, this category set an annual net cash flow record, blowing 2004 and 2012 out of the water with nominal net cash inflows more than 50% higher. 2013 was the first year that hybrid mutual funds' assets under management registered above $1 trillion, and had risen to more than $1.2 trillion as of year-end. We expect that cash will continue to flow into foreign-focused and hybrid mutual funds as investors continue to broaden their portfolio holdings. For more perspective on the reversal in bond fund flows versus equity fund trends (ETFs included), see the following historical chart. Here we've grouped annual net cash flows of all equity fund genres (we include hybrid funds here, as the Investment Company Institute indicates these funds have, on average, held 55%-65% equities historically) and all bond fund genres; the definitive shift occurring in fund flow trends in 2013 is hard to miss. Impressively, both equity and bond fund genres set annual all-time nominal records, as clearly depicted here — even surpassing respective extremes seen during 2000's tech bubble. Given the trends of the previous four years, we think these newfound trends have room to run. Kristen Hendrickson is a research analyst at Leuthold Weeden Capital Management

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