One of the advantages of putting together our annual Top Funds Guide, which starts here, is that it gives me the opportunity to step back and look at the broader trends encompassing the mutual fund industry. Last year, there were three notable trends: outflows from domestic stock funds, growth in the popularity of target date funds and a push by the financial community to promote alternative funds.
Historically, investors have put money into domestic stock mutual funds when the market is rising and have pulled money out of stock funds when the market is falling. Last year proved to be an exception. Even though the S&P 500 index returned 16.0%, investors moved money out of domestic stock funds. The Investment Company Institute’s (estimation of mutual fund flows reveal net outflows during 47 weeks out of the 53-week period spanning from the week ended January 4, 2012, to the week ended January 2, 2013.
There was some speculation that the outflows represented a shift from mutual funds to exchange-traded funds. Though such a shift may explain some of the outflows, the data suggests many investors were reducing their allocations to domestic stocks overall, or at least pure stock funds. Bond mutual funds experienced estimated net inflows for all but one week over the same period of time. Plus, the growth in the amount of assets managed by domestic stock ETFs was not large enough to both offset the total estimated outflows from domestic stock mutual funds and account for rising stock prices.
There is little doubt that all of the uncertainty that existed throughout 2012 caused some investors to be skittish about their allocations to equities. However, it is important to consider why you bought a mutual fund before you pull money out of it. Mutual funds are designed to be long-term investments. A good fund rewards shareholders who stick with it over the long term. Trying to time the market is extremely difficult. Trying to time the market by moving in and out of actively managed funds is even harder.
Some investors are opting for target date funds, rather than pure stock funds. The allure of target date funds is that they offer an “all-in-one” approach to allocation. Rather than worrying about whether to hold a stock or a bond fund, target date funds adjust their allocation relative to their shareholders’ age. You simply have to pick a fund with a target date that is approximate to your planned retirement date. Target date funds are also pulling in more assets from 401(k) and similar employer-sponsored retirement plans that utilize default allocation strategies. Though the premise of these funds may sound straightforward, they are complex instruments, as I explained in the October 2012 AAII Journal (“Target Date Funds: A Simple Premise, but Underlying Complexities,” available at AAII.com).
Investors are getting an initial look at how target date funds act after their target date has been reached. You can monitor such funds in a new category in our Guide, “Target Date: In Retirement.” At the other end of the spectrum, we have new categories for funds with target dates of 2030, 2040, 2050 and beyond.
Finally, you may have heard a pitch for alternative funds. These are funds intended to provide diversification benefits by offering returns that are uncorrelated to the performance of the stock or bond markets. These funds can follow hard-to-understand (and hard to explain) quantitative strategies. They have high expense ratios, which negatively impacts your realized return. Plus, their asset size is small compared to most other mutual funds, a sign that their so-called popularity may be more hype than actual fact. Nonetheless, they are an option and information about them can be found in the long-short category.
Due to the addition of new funds and categories, we pushed the space limitations of the printed magazine. As a consequence, information on our Investor Surveys has been omitted. You can find the latest numbers for our Sentiment Survey and our Asset Allocation Survey online at www.aaii.com/investor-surveys.
Wishing you prosperity
Charles Rotblut, CFA
Editor, AAII Journal