Time out! Where have all of the INVESTORS gone?

April 9, 2013 Categories: Portfolio Corner
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Recent mutual fund flows indicate that many investors have missed the equity market rally since 2009, as it appears they shifted investments out of equities and into bonds (based on the numbers shown). If investor emotions – rather than a change in investor goals – sparked this trend, it’s especially concerning.

Stop for a second and write down 3 observations about this chart

  • What do you see?
  • What don’t you see?
  • Find a pattern?
Equity fund flows

Sources: Weekly historical U.S. mutual fund cash-flow data from Investment Company Institute (ICI) February 28, 2013. Total equity flows = equity mutual fund flows (assets, sales, and redemptions as reported by fund companies to ICI). Russell 3000® Index: Russell Investments

Note: For my analytical readers, the following chart summarizes the flow data for fixed income and long term equity mutual funds:

Mutual Fund Net Flows

* Source: ICI

Now what do you see?  Have the goals of INVESTORS changed over the past 4 years?  Do baby boomers need to retire?  Have the emotions of macroeconomic events, elections and the media impacted portfolio returns?

Highlight #1: Since January 2009, long term equity mutual funds lost -$335.7 billion in net fund flows while fixed income flows were positive $1.1 trillion.

Now let this highlight soak in for a few moments….ok. Let me repeat this fact in a different way. The Russell 3000® index had cumulative returns from January 1, 2009 TO December 31, 2012 of over 76% while investors redeemed over $335.7 billion in net cash flow from equity mutual funds. What are these INVESTORS doing??

Bottom Line: Fixed Income was the recipient of $1.1 trillion in flows at the expense of equity and cash-equivalent like investments. I would suggest that not all of these flows were in response to rational, long term investment principles…but instead, as a response to emotional, macroeconomic events. This is NOT to downplay the challenging economic experiences of many U.S. households over the past 4 years, but to remind INVESTORS that equities are often a part of a long term, diversified portfolio.

Highlight #2: 2012 – The year investors redeemed $150.5 billion in long term equity funds while fixed income funds gained $306.1 billion in fund flows; despite the Russell 3000® index ended the year up 16.42%.

With the uncertainty surrounding the U.S. Presidential elections, fiscal cliff , Italy, Greece and other macroeconomic events , investors redeemed $150.5 billion from  equity mutual funds while appearing to  place the majority of those assets in fixed income or other cash like instruments.
What is interesting to note is that the record outflows in equity funds was happening while the Russell 3000® Index achieved returns of 16.42%! According to the ICI weekly fund flow data1, only 9 out of 52 weeks tracked in 2012 had positive flows into long term equity funds.

Here are some other important fund flow trends that were prevalent in 2012*

  • Domestic Equity Funds lost -$158.6 billion in net cash flow2
  • World Equity Funds gained $7.8 billion in net cash flow3
  • Hybrid Funds (which invest in stocks/bonds/cash) gained $47.3 billion in net cash flow4
  • Fixed Income Funds had only 1 week (yes 1 week) of negative flows in 20125

* source: ICI

What does all of this mean?

Bottom Line: Despite the Russell 3000® Index exceeding the returns of the Barclays Aggregate Index in 2012, mutual fund flows suggest that investors were seeking the safety of fixed income products . The impact of missing an equity return of 16.4% has significant portfolio implications for advisors and investors alike.

Have INVESTORS goals changed or have some investors simply ignored the fact that equities are part of a long term diversified portfolio….relying instead on an emotional response to macroeconomic events outside of their control?

Highlight #3: 2013 equities fund flows Are positive through February 2013 with $44.7 billion in flows while fixed income is positive $56.3 billion.

Look at the graph of the Russell 3000 Index vs. Equity Mutual Fund Flows; specifically in 2013. Notice a pattern? Investors poured money into Equity Mutual Funds in 2013 by INVESTING $44.7 billion through February 2013.

What happened? What changed? Was the budget deficit solved? Did tax rates go down?

Did we have so many new, long term Equity INVESTORS that we had 8 straight weeks of positive flows into equities…or has something changed? Where was this money the past 4 years?
Investors naturally want to be with winners. At the first blink of Fixed Income returns experiencing a negative return of -0.20%6 (as measured by the Barclays Aggregate Bond Index), INVESTORS may be seeing apparent value in equities after the Russell 3000® Index returned 6.89% year-to-date through 2/28/13.

From the questions we receive almost daily, advisors and investors are waiting for an equity pullback so that they can move “back into” the market. Again, what part of their long term goals/risk tolerance has changed to make an INVESTMENT decision based on market action (equity year-to-date performance) rather than practicing fundamental asset allocation in building portfolios that help INVESTORS reach their goals with greater certainty?

Bottom Line: For the past 4 years, many investors may have worried too much about the emotional aspect of investing while ignoring one of the fundamental principles of portfolio construction…time. Equity investing requires the discipline of having an investment strategy for INVESTORS rather than a market outlook.

An investment strategy that relies on asset allocation, investment discipline, annual rebalancing , and a financial plan, can help INVESTORS navigate market volatility to focus on what they can control (risk tolerance and asset allocation) and not the effects of macroeconomics, which they cannot control.

Brad Jung is Director, Northwest Division Sales, U.S. Private Client Services

1Investment Company Institute (ICI) reports on total estimated inflows to long-term mutual funds.

2Domestic equity funds are those that invest primarily in shares of U.S. corporations.

3World equity funds are those that invest primarily in non-domestic (non-U.S.) corporations.

4Hybrid funds are those that invest in a mix of equity and fixed-income securities.

5Fixed income funds are those that invest primarily in bonds and other debt instruments.

6Barclays Aggregate Bond Index: with income reinvested, generally representative of intermediate-term government bonds, investment-grade corporate debt securities and mortgage-backed securities.

Russell 3000® index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.

Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

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