Friday, December 30, 2011

Zero rates and risk aversion drove mutual fund flows

The trend of preference for fixed income mutual funds over equity funds that started in 2009 continues today. Recent data from Credit Suisse shows clear risk aversion with taxable bond fund flows beating out equities by a substantial amount.

Source: Credit Suisse

What about non-taxable bond funds?  For a while there it was rough going with Meredith Whitney hyping up the doomsday scenario for munis.  Fund outflows in late 2010 spiked, but as investors started to realize that default rates are not going to be nearly as extreme as predicted, investors started coming back, attracted by great after-tax returns.

Source: Credit Suisse

In the equity mutual fund space the period of 2009-2010 saw many investors betting on foreign equities (see chart below), particularly emerging markets.  By the second half of 2011 that bet wasn't working out for them and fund outflows picked up from both domestic and the foreign funds.

Source: Credit Suisse

Some have attributed the equity mutual fund outflows to recent preferences for ETFs because of the ability to trade those intraday. That is indeed the case as equity ETFs have taken market share from mutual funds, though not enough to offset the overall decline.

Source: Credit Suisse
But some of this ETF flow increase has been driven by institutional investors as hedge funds and even endowments got a taste for the liquidity of ETFs. Retail investors on average continue to shy away from equities.

These trends are likely to continue into 2012 as the combination of stresses in the eurozone and zero short-term rates will combine risk aversion with search for yield to favor bond mutual funds over equities.
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