Two Notable Mutual Fund Trends
Thursday, February 6, 2014
Charles Rotblut, CFA
AAII Journal Editor

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 27.9%, down 4.3 points
  Neutral: 35.7%, up 0.6 points
  Bearish: 36.4%, up 3.6 points

Long-term averages:
  Bullish: 39.0%
  Neutral: 30.5%
  Bearish: 30.5%

Take the AAII Sentiment Survey »

In writing this year’s mutual fund guide, there were two trends I noticed but did not have the space to mention. The most prominent of these was the net inflow of cash into equity funds. Last year was the first with positive inflows into stock mutual funds since the financial crisis.

There are two key metrics for the mutual fund industry. The first is assets under management (AUM). AUM is the amount of investment dollars being managed. It can be increased through positive returns and by having investors deposit more money than they withdraw. This is why flows are the second key metric. Flows measure how much money is coming in from investors and how much is being withdrawn. Flows matter because asset managers charge a percentage based on AUM. Hence, the more money under management, the more profitable it is to be a money manager.

Over time, trends in flows have developed. Specifically, flows into equity funds rise when the market is doing well and they fall when the market is doing poorly. Since 2007, equity mutual funds had experienced net outflows for five consecutive years according to data compiled by the Investment Company Institute (ICI). Last year broke this trend as mutual fund companies enjoyed nearly $161 billion of inflows into their stock funds.

To put the number in perspective, 2013 inflows were the fifth highest in at least 30 years. The only years since 1984 with higher inflows were 1996, 1997, 1999, 2000 and 2004. Notice that four of those years are from the tech bubble.

These numbers are not surprising to those of us who look at market history. Rising stock prices attract investment dollars, while falling prices cause investors to sell their equity holdings. It’s risk aversion at work. What happens over time is that this behavior causes investors to lock in big losses by pulling money out of stock funds when the market is down and miss out on big gains by waiting for the market to rebound before putting money back in—a buy high, sell low mentality. The net result is that investors underperform the very same funds they are investing in. I’ll show how dangerous this behavior is later this year in the AAII Journal.

One trend that may potentially alter how fund flows are looked at in the future is the growth of target date funds. These funds now account for 10 of the 50 most widely held funds tracked in the print edition of our mutual fund guide. Vanguard Target Retirement 2025 (VTTVX) ranks ninth with AUM of $28.0 billion, slightly more than the very popular Vanguard 500 Index (VFINX), which had $27.8 billion in AUM at the end of 2013.

(In case you are wondering, 2020 funds are the most popular. There are three of them on our 50 most widely held list, with combined AUM of nearly $53 billion.)

Target date fund providers have 401(k) plans to thank. Companies using auto-enrollment and default allocation strategies are steering workers to target date funds. From a fiduciary standpoint this makes sense since these funds are designed to adjust their allocation as an investor nears and enters into retirement. Many workers are also likely choosing them for the implied simplicity the funds’ names suggest, even though some surveys have suggested workers don’t necessarily understand how these funds are actually designed to work.

More on

The Week Ahead

Nearly 60 members of the S&P 500 will report earnings next week. Included in this group is Dow component Cisco Systems (CSCO), which will report on Wednesday.

The first economic report of note will be January retail sales and December business inventories, which will be released on Thursday. Friday will feature December industrial production and capacity utilization, the preliminary University of Michigan consumer sentiment survey, and January import and export prices.

Federal Reserve Chairman Janet Yellen will give her first semi-annual monetary testimony to Congress on Tuesday and Thursday. Philadelphia president Charles Plosser will speak on Tuesday and St. Louis president James Bullard will speak on Wednesday.

The Treasury Department will auction $30 billion of three-year notes on Tuesday, $24 billion of 10-year notes on Wednesday and $16 billion of 30-year notes on Thursday.

AAII Sentiment Survey

Short-term pessimism among individual investors rose to levels not seen last since last August, according to the latest AAII Sentiment Survey. Meanwhile, bullish sentiment fell for the fifth time in six weeks.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 4.3 percentage points to 27.9%. This is the lowest level of optimism registered by our survey since April 18, 2013. It is also the first time bullish sentiment has been below 30% since August 22, 2013. The historical average is 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged, edged up 0.6 percentage points to 35.7%. This is the fifth consecutive week with a neutral sentiment reading above the historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 3.6 percentage points to 36.4%. This is the highest level of pessimism registered by our survey since August 22, 2013. It is also the first time bearish sentiment has been above its historical average of 30.5% on consecutive weeks since September 5, 2013.

As noted above, optimism among individual investors continues to fall. Bullish sentiment is down a cumulative 27.2 percentage points since reaching 55.1% on December 26, 2013. Bearish sentiment, meanwhile, is up a cumulative 17.9 percentage points over the same period.

The market’s pullback continues to cast clouds over AAII members’ short-term outlook, likely heightening concerns about both stock valuations and whether the market established a short-term top at the start of the year. Also playing a role is the pace of economic growth and Washington politics. Tempering the pessimism is earnings growth, economic growth and the Federal Reserve’s tapering of its bond purchases.

This week’s special question asked AAII members what impact emerging markets are having on their six-month outlook for U.S. stocks. Approximately 30% of respondents said emerging markets are not influencing their outlook for U.S. stocks, while 23% said emerging markets are having a negative influence. The level of how negative the influence was varied by respondent, but many of the respondents in this second group thought emerging market countries are creating downward pressure on U.S. stocks. A smaller group, about 10%, said emerging markets are having a small impact on their outlook for U.S. stocks.

» Take the AAII Sentiment Survey

AAII Asset Allocation Survey

January Asset Allocation Survey results:
Stocks/Stock Funds:
    65.6%, down 2.7 points
Bonds/Bond Funds:
    17.0%, up 1.8 points
    17.4%, up 0.9 points

Asset Allocation Survey details:
     30.9%, down 2.4 points
Stock Funds:
     34.7%, down 0.3 points
     3.5%, up 0.2 points
Bond Funds:
     13.5%, up 1.6 percentage points

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Individual investors modestly reduced their allocations to stocks and stock funds last month, according to the January AAII Asset Allocation Survey. Even with the decrease, equity allocations remained above their historical average for the longest consecutive period since the financial crisis began.

Stock and stock fund allocations declined 2.7 percentage points to 65.6%. January was the 10th consecutive month, and the 12th out of the past 13, with equity allocations above their historical average of 60%.

Bond and bond fund allocations rebounded by 1.8 percentage points to 17.0%. The increase puts fixed-income allocations above their historical average of 16% for the 54th time in the past 56 months.

Cash allocations increased 0.9 percentage points to 17.4%. This made January the 26th consecutive month with cash allocations below their historical average of 24%.

The current 10-month streak of above-average equity allocations is the longest such streak since the financial crisis. Equity allocations stayed above 60% for 11 consecutive months between September 2006 and July 2007. Last year’s rally and the recent record highs helped to keep individual investors optimistic, make equities more attractive and boost the value of portfolio stock holdings.

Short-term sentiment in our weekly survey waned throughout January, however. The decrease in optimism about the short-term direction of stock prices and a pullback in bond yields likely contributed to the increased fixed-income and cash holdings last month.

Last month’s special question asked AAII members what impact, if any, the Federal Reserve’s decision to taper its bond purchases will have on their portfolio allocations. There was no consensus, though the largest group (42% of respondents) did not anticipate any impact. About 15% of respondents said they have reduced their bond allocations, while 5% shortened the duration (interest rate sensitivity) of their fixed-income holdings. Approximately 8% of respondents said they don’t hold any bond funds.

Here is a sampling of the responses:

  • “None at this point; the taper is too small to have a large impact.”
  • “None at this time. If interest rates begin to rise, I may adjust my bond fund allocation.”
  • “It will delay my purchasing of any additional bonds and bond funds, with the possible exception of very short duration bonds and bond funds.”
  • “I increased my cash allocation relative to bonds. I have emphasized short-maturity bonds and bond funds in my portfolio.”
  • “I will likely sell all of my bond funds, but hold the individual bonds until maturity.”

» Take the AAII Asset Allocation Survey