Mutual Fund Flow Trends
mutual fund

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:

Domestic Equity and Taxable Bond Mutual Fund Flows

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:

ICI - Net New Cash Flow to Index Mutual Funds

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:

ICI - Total Net Assets and Number of ETFs

(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:

World Equity, Hybrid and Municipal Bond Mutual Fund Flows

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.

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Turn-of-the-Year Market Trends

‘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:

Monthly S&P 500® Price Returns 1929-Now

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:

Monthly Stock Performance

However, from a monthly peak-close perspective, December is unremarkable, as an article in The Wall Street Journal illustrates:

Average Monthly Peak Gain in DJIA

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:

Average Market Performance in December and January

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™:

S&P 500® Return in December 2013

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:

Average January Relative Performance of MLQS Quality Indices

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.

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