Mutual Fund Flow Trends
December 30, 2013
Inflation- and Dividend-Adjusted Market Peaks
In 2013, cumulative flows of stock and bond mutual funds departed from their trends in the previous six years. According to data from the Investment Company Institute (ICI), from January 2007 through December 2012 domestic equity funds suffered a cumulative $613 billion of outflows, as the following chart compiled by Alpholio™ shows:
Withdrawals from stock funds accelerated during the 2008-09 market downturn. On average, from 2007 to 2012 the annual outflows were about $94 billion, as illustrated by the trend line in the above chart.
It is worth noting that the domestic equity category includes both actively-managed and index funds. The outflows can be attributed to the former funds because the latter ones actually had inflows in each of these years:
In contrast to domestic equity funds, in the same period taxable bond funds benefited from about $1,045 billion of inflows. This flow disparity was caused by multiple factors. On the one hand, actively-managed stock mutual funds also lost assets under management (AUM) to exchange-traded funds (ETFs), the assets and number of which approximately doubled from 2007 to 2012:
(To be precise, at the end of 2012 about 48% of ETFs’ net assets were in domestic equity. In addition, ETF flows can be distorted by institutional and foreign investors, as well as seasonal effects.) On the other hand, inflows to bond funds were caused by the low interest rates and investors’ increased risk aversion after the financial crisis.
In 2013, the situation changed. After the Fed’s indication of a possible tapering in quantitative easing and a subsequent rise in interest rates, taxable bond funds experienced approximately $112 billion in withdrawals from June through December 18, according to Alpholio™’s estimates. For domestic equity funds, the long-term outflow trend was reversed in January 2013. According to Alpholio™ calculations, these funds gained about $19 billion of cumulative year-to-date inflows, undoubtedly caused by a strong performance of the stock market.
The following chart compiled by Alpholio™ demonstrates cumulative flows in other fund categories:
Except during the market downturn, flows into world (foreign) equity and hybrid (stock + bond) equity funds were generally positive. Municipal bond funds had outflows in late 2008, late 2010 and early 2011, and the second half of 2013. Taxable and municipal bond funds collectively lost about $81 billion so far in 2013, according to Alpholio™ estimates.
Recent figures from Bloomberg generally corroborate these findings:
Mutual funds that buy American equity took in about $21 billion in 2013, according to ICI data, while ETFs received $141 billion, Bloomberg data show. Bond funds had $67 billion taken out.
However, as an article in InvestmentNews points out, the vast majority of net inflows into U.S. stock funds this year accrued to index funds of one investment management company, while actively-managed funds sustained net outflows:
Vanguard, best known for its index funds and emphasis on low-cost investing, received $41.4 billion of net inflows into its U.S equity funds in 2013 through Nov. 30, according to Morningstar Inc. U.S. stock funds not managed by the company founded by John C. Bogle in 1974 took in a net total of about $1.1 billion.
Vanguard’s suite of actively managed equity funds, including its $39 billion Vanguard Primcap Fund (VPMCX), has had $5 billion of net inflows for the year through November.
Though still negative, over the first 11 months of 2013, actively managed U.S. stock funds have had only $10 billion of net outflows, down 92.3% from $130 billion in 2012.
In sum, although 2013 has been a year of departure from long-term trends in some cumulative flows, actively-managed domestic equity funds continued to suffer net outflows, while their index and ETF counterparts enjoyed inflows. As for bond funds, it can be expected that their recent net outflows will persist in the short run in an environment of rising interest rates.
December 26, 2013
Lack of Performance Persistence Matters in the Long Run
With a strong performance of equities in 2013, major market indices have reached peak levels. In an attempt at accuracy, many articles in the financial media adjust index values for inflation. The conclusion is that the market, as measured by the Dow Jones Industrial Average (DJIA), has surpassed record levels from early 2000 only very recently on an inflation-adjusted basis. On the other hand, a broader market benchmark, the S&P 500® index, is still about 15% below its inflation-adjusted 2000 peak. Having suffered significant downturns in both 2000 and 2008, the NASDAQ-100 index is significantly below both its nominal and inflation-adjusted historical highs.
The problem is that in all of these assessments, a price level of each index is used. Would the findings be different if indices were also adjusted for reinvested dividends to account for total returns? To determine that, Alpholio™ compiled inflation- and dividend-adjusted prices of two representative exchange-traded funds: the SPDR® Dow Jones® Industrial Average ETF (DIA) and SPDR® S&P 500® ETF (SPY). These ETFs are long-lasting and popular implementations of their respective indices. To adjust for inflation, the Consumer Price Index – All Urban Consumers (CPI-U) was used.
A conventional price chart shows that DIA has indeed just matched an inflation-adjusted record high from January 2000:
However, a chart for DIA with reinvested dividends indicates that the previous inflation-adjusted peak from October 2007 was already surpassed in mid-January 2013:
Similarly, a price-only chart illustrates that SPY is still about 13% below its inflation-adjusted top from March 2000:
On the other hand, the chart with dividends factored in demonstrates that SPY already exceeded the previous inflation-adjusted maximum level in May 2013:
According to S&P Capital IQ, since the late 1920s dividends constituted about 45% of the total return of the stock market. Therefore, any assessment of the current market level has to adjust not only for inflation but also for reinvested dividends. From that standpoint, historical market peaks were quietly surpassed much earlier this year. Time and again, media focus is on generating simplified headlines rather than noting true events.
December 20, 2013
Turn-of-the-Year Market Trends
The December edition of the semi-annual S&P Persistence Scorecard brings better news than the July report — performance persistence of top mutual funds has slightly improved. However, percentages of domestic equity funds remaining in the top half of population for three or five consecutive 12-month periods were generally lower than those expected by mere chance.
Only 7.23% of all funds remained in the top quartile for three years and 2.11% for five years to September. While this beat random expectations of 6.25% and 0.39%, respectively, figures for the same periods ending in March were 4.69% and 0.18%.
In this context, an InvestmentNews article says that
S&P’s findings reinforce the idea that short-term performance chasing in mutual funds is likely to end badly for advisers, but for long-term investors, the lack of persistence doesn’t necessarily mean a bad outcome, provided you can stomach the volatility.
The article gives an example of this year’s top-performing large-cap blend fund, the MFS® Equity Opportunities Fund (SRFAX; Class A shares), which beat 90% of its peers and the S&P 500® index by annualized 2% in the trailing five years, despite a rocky performance:
The fund’s journey to five years of outperformance wasn’t smooth though. In 2009 it ranked in the bottom 10th percentile of large-cap blend funds and in 2011 it ranked in the bottom half of its category.
The article concludes that:
So if you can handle a fund that dips every now and again, without a big change to the investment process or management, the lack of persistence shouldn’t matter over the long run.
This example, however, forgoes important details. First, although Morningstar classifies the fund in the large-blend category, the prospectus benchmark for the fund is the Russell 1000® index. Unlike the S&P 500®, that benchmark includes medium-capitalization equities. As of this writing, the annualized five-year return of the fund was 19.09% vs. 18.41% of the iShares Russell 1000 (IWB), a difference of only 0.68%.
Second, compared to its stated benchmark the fund’s holdings are tilted toward mid- and small-cap stocks (collectively, about 46%) at the expense of giant-cap ones. This, again, indicates, that a pure large-cap index is an inappropriate reference.
Third, let’s use Alpholio™ tools to further peek under the fund’s hood. Here is a chart of weights of exchange-traded funds (ETF) in the reference portfolio for the fund:
The fund had top-four equivalent positions in the iShares S&P 500 Growth ETF (IVW; average weight of 23.8%), iShares S&P Mid-Cap 400 Growth ETF (IJK; 23%), PowerShares Dynamic Market Portfolio ETF (PWC; 21.2%), and iShares Morningstar Mid-Cap Growth ETF (JKH; 6.8%). This underscores the fund’s tilt toward not only mid-cap but also growth stocks.
Relative to the reference portfolio, the fund’s performance in the same analysis period was unimpressive:
The fund underperformed in 2009, so on a cumulative basis, its RealAlpha™ did not rebound until 2013. By this November, an investor who started with the fund in early 2005 would have not yet beat the reference ETF portfolio, as shown by the lag RealAlpha™ curve. In addition, the reference portfolio exhibited a lower volatility. (To get more information about this and other funds, please register on our website.)
The lack of performance persistence in mutual funds does matter in the long run and is more pronounced the longer the run is. In addition, as the above analysis demonstrated, relative performance heavily depends not only on the timeframe of the analysis, but also on the proper choice of the benchmark that fully adjusts for a fund’s risk.
December 17, 2013
Year-End Market Predictions
‘Tis the season for the usual pondering of the turn-of-the-year market trends. A report from the Merrill Lynch Equity and Quantitative Strategy team shows that January has statistically delivered the highest monthly returns and second-highest (after December) frequency of positive returns in all months:
In contrast, a blog post in The Wall Street Journal demonstrates that the December rally is more pronounced and consistent across observation timeframes than the January one, which vanished in the last 20 years:
However, from a monthly peak-close perspective, December is unremarkable, as an article in The Wall Street Journal illustrates:
This finding is less meaningful because it only determines the magnitude of monthly oscillation, rather than a complete return in each month.
According to the post, an interesting return pattern emerges in the last and first month of the year:
A pullback in the middle of December is caused by tax-loss selling by traders, window dressing by fund managers, and portfolio realigning by investors. Once this is over, a rally ensues. However, according to the article, it is statistically significant only in a short period at the turn of the year:
There is one version of the Santa Claus rally that enjoys strong historical support: the last five trading sessions of December and first two of January… Since the Dow was created in 1896, it has gained an average of 1.7% during this seven-trading session period, rising 77% of the time. That is far better than the 0.2% average gain of all other seven-trading-session periods of the calendar.
Here is how the S&P 500® returns look so far this December, as compiled by Alpholio™:
Despite a pullback early in the month, there is some similarity to the above long-term average return pattern. Of course, only time will tell if the rest of the pattern is followed.
The seasonal effects are mostly pronounced in small-cap stocks. In addition, the report claims that lower-quality stocks strongly outperform in January:
Loading up on “junk” equities for the sake of a superior one-month return is probably not advisable. If anything, this might be an opportune time to tilt the portfolio towards high-quality, cash-rich companies, which Merrill Lynch itself recommends in its 2014 outlook. Seasonal market trends, such as the Santa Claus rally or January effect, no matter how likely, should not cloud a long-term investment perspective.
December 12, 2013
Beating the Market, an Elusive Goal
At year’s end, many analysts make market predictions for the next twelve months. The S&P 500® index is a popular target for such forecasts since it is commonly used as a market proxy and its constituent stocks are widely followed. Hence the bottom-up analysis — a sum of estimates for all individual equities makes an index forecast.
Who better to predict the S&P 500® index level than the S&P itself? Let’s take a closer look at their forecast accuracy. The following chart compares the predicted to actual values of the index, which Alpholio™ compiled from historical editions of S&P Capital IQ’s The Outlook:
To be exact, these 12-month targets were typically set in early to mid December of the preceding year, while the actual index values were recorded on the last trading day of the predicted year. Also, dividends were not taken into account in this price index.
The immediate takeaway from this chart is that the forecast for 2008 vastly overestimated the actual price: 1,650 vs. 903, or by about 83%! The financial crisis and its magnitude caught everyone, including members of the S&P Capital IQ’s Investment Policy Committee, by surprise. Excluding that outlier year, here are the index prediction and annual return statistics:
||Prediction vs. Actual
||Actual Index Return
The sample is admittedly small, under ten data points. But a trend is emerging — on average, S&P predictions underestimated the actual index. This tendency is further illustrated by the following chart from FactSet’s Targets & Ratings report:
The chart shows how a bottom-up target price (dashed line) moved almost in parallel with the actual index (solid line) in the 12 months through October. In other words, predictions were adjusted upwards with a lag as it became evident that original estimates were likely going to be soon surpassed. (As a side observation, almost half the stocks in the S&P 500® were rated a Buy, slightly less than half a Hold, and only about 5% a Sell. Even a booming market, a less optimistic distribution would be intuitively expected.)
S&P offers another interesting prediction for the next year:
We also believe 2014 could be one of those years in which the S&P 500 is up for the entire year but suffers through a pullback of 5%-10% (and more likely a correction of 10%-20%) before ending the year higher than where it started. One reason is that 26 months have elapsed without the S&P 500 slipping into a correction, versus the average of 18 months (and median of 12 months) between declines of 10% or more since 1945.
If statistically the market is overdue for a correction, let’s also hope that by the same token S&P underestimated the 500® index’s value in 12 months from now. In that case, we should be expecting a price of about 1930 instead of the current target of 1895, while keeping in mind that perfect market predictions are virtually impossible.
December 9, 2013
Analysis of Baron Growth Fund
Contrary to the main thesis of an article in The New York Times and despite emphatic proclamations, beating the market remains an elusive goal. A mutual fund manager, Robert A. Olstein, featured in the article, finds the arguments for index funds personally insulting:
“It’s like saying mediocrity is O.K. — that it’s more than O.K., it’s the best that anyone should hope for,” Mr. Olstein says. “It’s saying a guy like me can’t beat the market — that he shouldn’t even bother trying. That’s wrong! It really ticks me off. I can beat the market. I have beaten the market.”
To verify this statement, let’s take a closer look at the performance record of his Olstein All Cap Value (formerly known as Olstein Financial Alert). First, some information about cost. Class C shares of the fund (OFALX), established in September 1995, carry a hefty 2.31% expense ratio, including a sizable 12-b1 fee of 1%. In addition, there is a 1% contingent deferred sales charge (CDSC) imposed if an investor redeems Class C shares within the first year of purchase.
The Adviser Class shares (OFAFX), which became available four years later, have an expense ratio one percentage point lower than Class C shares. However, as their name implies, these shares are available to individual investors only through investment advisers who typically charge 1% in advisory fees. Therefore, from an individual investor’s perspective, the cost of both classes of shares is comparably high, which makes it difficult for the fund to outperform on an after-fee basis.
Second, there is an issue of a proper benchmark for the fund. As its name suggests, the fund pursues undervalued stocks in a broad spectrum of market capitalization. Yet its primary prospectus benchmark is the large-cap S&P 500® index (the secondary benchmark is the Russell 3000® index that includes smaller-capitalization stocks). Historically, Morningstar classified the fund into the mid-blend category; only in 2010 did the category change to large blend. As of the end of October 2013, about 40.2% of the fund’s holdings were still in the mid- and small-cap equities.
Third, the article states that
From its inception through November this year, including fees, his flagship fund returned 10.7 percent, annualized. That’s more than 2.4 percentage points better than the Standard & Poor’s 500-stock index, and substantially better than comparable small-cap indexes.
The problem is that this outperformance mostly stems from a relatively short period in the fund’s 18-year history. Here are the cumulative returns of the fund and the S&P 500® index in various periods:
*through December 6
The above data show that the fund’s lifetime outperformance of its primary benchmark can be mostly attributed to a relatively short four-year interval from the beginning of 2000 through the end of 2003. In other periods, the fund’s returns were sub-par.
What about risk-adjusted performance of the fund, determined with the simplest (single-factor) approach? Here are the fund’s Sharpe Ratios vs. those of its primary and secondary benchmarks implemented by the SPDR® S&P 500® ETF (SPY) and SPDR Russell 3000® ETF (THRK), respectively:
The Sharpe Ratio figures corroborate our cumulative return findings: a more recent performance of the fund was also unimpressive on a traditional risk-adjusted basis.
The following Alpholio™ chart illustrates a relative performance of the fund vs. its reference portfolio of exchange-traded funds (ETFs):
In this analysis period spanning almost nine recent years, the cumulative RealAlpha™ of the fund exhibited a mostly downward slope. This indicates that the individual stock picking skills of the management team left a lot to be desired. In addition, the annualized volatility of the reference portfolio was slightly lower than that of the fund.
Here is the dynamic composition of the fund’s reference portfolio in the same analysis period:
The fund’s top three equivalent positions were in the Guggenheim S&P 500® Equal Weight ETF (RSP; average weight of 24.8%), Vanguard Consumer Discretionary ETF (VCR; 19.3%), and SPDR Russell 3000® ETF (THRK; 8.6%).
In conclusion, the fund did indeed beat the market, but only in terms of returns and mostly in one, relatively short and long-ago period of its 18-year lifespan. The fund’s performance after adjustment for risk, using either a traditional approach or the modern Alpholio™ methodology, has been quite unimpressive. Thus, beating the market, at least for this fund’s manager, remains more a fleeting gain than a solidly reachable goal.
To learn more about the Olstein All Cap Value fund, please register on our website.
December 5, 2013
Active vs. Passive in the Bogle Family
Unlike many of its peers, Baron Growth Fund (BGRFX; retail shares) prefers a buy-and-hold strategy. As an article in The Wall Street Journal points out, the fund’s turnover ratio is only about 10% vs. about 84% of an average mid-cap growth fund.
The fund typically invests in small-cap stocks and divests them as they reach a mid-cap level after an average holding period of eight years. Hence, a mixed classification of the fund by Morningstar: small-cap growth (SG) category through 2010, and mid-cap growth (MG) afterwards.
This strategy has apparently succeeded:
Through Nov. 30, Baron Growth has gained an average of 14.1% a year since inception, outpacing the 7.9% annual return of the Russell 2000 Growth Index, according to Morningstar. This year, through November, the fund is up 34.8%, vs. an average 30.8% for Morningstar’s midcap-growth category.
Or, has it? The fund currently has about $8.1 billion in assets compared to a median of $433 million for the small-cap growth and about $758 million for the mid-cap growth categories (average figures are skewed higher due to a few big funds). A large size makes it more difficult for this smid-cap fund to outperform. As of the beginning of December 2013, the annualized 10-year return for the fund was 10.27%, compared to 10.08% for the iShares S&P MidCap 400 Growth ETF (IJK) and 10.84% for the iShares S&P Small-Cap 600 Growth ETF (IJT).
The following chart shows the relative performance of the fund from the Alpholio™ perspective:
The cumulative RealAlpha™ of the fund had three distinct phases: it was mostly flat from early 2005 through early 2008, subsequently declining through 2011, and finally rebounding in early 2012. In the entire analysis period, the annualized RealAlpha™ was negative, and the volatility of the fund was higher than that of its reference ETF portfolio. It is also worth noting that the lag cumulative RealAlpha™ curve was generally below the regular curve, which indicates that some of the new investment ideas were not as good as the previous ones. (For a detailed explanation on how to interpret the relationship between these curves, please see the FAQ.)
The next chart illustrates percentage weights of ETFs in the reference portfolio for the fund:
The fund’s three equivalent positions with highest average weights were in iShares S&P Mid-Cap 400 Growth (IJK; average weight of about 18.4%), iShares Morningstar Mid-Cap Growth (JKH; 15.6%), and iShares S&P Small-Cap 600 Growth (IJT; 11.8%).
An equivalent position in the iShares Russell 2000 Growth ETF (IWO), included in the Other component in the above chart, had an average weight of only 8.1%. This makes questionable the choice of the Russell 2000 Growth index as the prospectus benchmark for the fund.
The article cites one potential negative — the fund has a 1.32% expense ratio. However, its manager claims otherwise:
Mr. Baron says the fund is a bargain considering its performance.
Well, the above analysis clearly demonstrated that the investor would be better off, from both the return and risk perspectives, by substituting the fund with a dynamic portfolio of ETFs. For more information about Baron Growth, please register on our website.
December 2, 2013
An article in The Wall Street Journal contrasts passive and active stock investment strategies of the two members of the Bogle family. The father, John ‘Jack’ Bogle, practices the former approach
Jack Bogle is the founder of Vanguard Group and considered by many investors as the father of passive investing, or using funds that try to capture the return on an entire broad basket of securities, such as the S&P 500.
while the son, John Bogle Jr., prefers the latter one
The junior Mr. Bogle then started Bogle Investment Management LP, his current firm, in 1999. Like many active managers, he uses computer models to analyze earnings surprises, relative stock valuations, corporate accounting and the like.
Results have apparently been in favor of active management:
The flagship Bogle Small Cap Growth Fund was launched 14 years ago and has delivered an annualized return since then of 12.4%, compared with 8.6% for its benchmark index, the Russell 2000, according to Morningstar.
However, this statistic is misleading. As of the end of November 2013, the 10-year annualized return of the Bogle Small Cap Growth Fund (BOGLX) was 8.89%. The annualized return of the iShares Russell 2000 ETF (IWM), which follows the fund’s stated benchmark, was 9.01% in the same period. Moreover, the iShares Russell 2000 Growth ETF (IWO), implementing a benchmark more relevant to the fund, returned an annualized 9.19%.
The fund’s lifetime outperformance cited by the article is mostly due to the 1999-2000 period when small-cap growth stocks enjoyed a strong run-up during the technology market bubble. In its first year since inception on October 1, 1999, BOGLX returned about 69.9% compared to about 21% of the Russell 2000® index in the same period.
Let’s also take a look at the fund’s performance from the Alpholio™’s perspective. Here is a cumulative RealAlpha™ chart since early 2005:
The fund started to significantly underperform its reference portfolio of exchange-traded funds (ETFs) in mid-2007, well before the onset of the financial crisis. From mid-2008 to mid-2012, the fund’s cumulative RealAlpha™ was relatively flat. The fund began to outperform only about a year ago:
This year, John Bogle’s fund has generated total returns of 40%, through Tuesday, according to Morningstar, compared with 35% for the Russell 2000 and 34% for the similar Vanguard fund.
The following chart shows the percentage ETF weights in the fund’s reference portfolio over the same analysis period:
Just three ETFs, iShares Russell 2000 Growth (IWO), Vanguard Small-Cap Growth (VBK), and iShares Morningstar Small-Cap (JKJ), collectively accounted for about 85% of the reference portfolio on average. This indicates that a substitution of the fund with a better-performing collection of alternative investments was relatively straightforward.
It looks like the elder Mr. Bogle was right after all — it is difficult for a stock picker to outperform on a truly risk-adjusted basis. To access more information on BOGLX, please register on our site.