2010 Ends on Cautious Note for Bond Funds, Steady Gains in Demand for Stock Funds

Jan. 12, 2011 - PRLog -- Demand among US investors for stock mutual funds accelerated by year-end, with aggregate inflows to equity funds, including ETFs, near $25 billion during December, according to Strategic Insight, a business intelligence provider to the worldwide fund industry. As seen throughout 2010, international stock fund inflows rose, while improvement in flows to domestic-oriented stock funds was modest. December inflows were among the highest in recent years, and mirror a steady brightening in investor sentiment.

After attracting $1 trillion globally since the beginning of 2009, December marked a turning point, albeit temporary in our view, for bond funds. In contrast to stock funds, rising interest rates, NAV declines, and year-end rebalancing triggered a spike of bond fund redemptions. December witnessed an estimated $26 billion of net outflows among all bond funds (including ETFs), the largest dollar amount since the peak of the financial crisis on October 2008. Nevertheless, global bond funds, floating rate funds, and high yield funds were a few investment areas with positive inflows.

“Because many investors engage in year-end portfolio adjustments and tax-related moves, December is a difficult month from which to draw firm conclusions. However, it is clear that stock investor sentiment is slowly improving,” said Avi Nachmany, SI’s Director of Research.

Not including ETFs, international and global funds in December garnered net inflows of $14 billion, while domestic equity mutual funds saw net outflows of $9.5 billion. This reflected a continuing demand among investors for international diversification, including a growing allocation to emerging markets; December was the seventh straight month that international and global equity funds saw positive flows.

December’s bond-fund outflows included roughly $10 billion in outflows from taxable bond funds, although global bond funds saw net inflows in December due to investors’ increasing interest in global diversification. Also, high-yield bond funds saw inflows in December, which was a sign of an increasing appetite for risk among some investors – and in many ways an extension of improving equity sentiment. Muni bond funds saw net outflows of $13 billion in December, driven by a flood of supply (spurred by Build America Bonds) and worries about state and municipal government balance sheets.

For the full-year 2010, long-term mutual funds attracted net inflows of $245 billion (not counting additional inflows to ETFs and VAs funds). That included $222 billion in net inflows to bond mutual funds – the second-largest flow numbers to bond funds ever, after 2009’s record inflows of $350 billion – and $23 billion in net inflows to equity funds, up from $14 billion in 2009 inflows to equity funds.

Money-market funds saw net outflows of $6.5 billion in December, a decline from the $25.1 billion in net inflows they saw in November.

2011 Outlook: With the Federal Reserve aiming for low interest rates in early 2011, Strategic Insight views the spike in bond fund redemptions as a short-lived spike. “We still expect a rebound in bond fund demand in the first half of 2011,” said Nachmany, “as investors will continue to crave higher-yielding investments than available in banks and money-market funds. For some, the focus on income and risk aversion will persist through 2011.”

In addition, investors and financial advisors will continue to embrace asset allocation but reconsider how diversification is best achieved. Investors should continue to gravitate towards less-correlated asset classes and strategies, feeding demand for “alternative” funds and funds with more flexible mandates. And demand should continue in 2011 for funds that offer packaged solutions, in either fund-of-fund format or in go-anywhere, tactical asset allocation funds. “The US mutual fund industry is going through a period of unprecedented innovation these days, which will benefit investors for years to come,” Nachmany said.

ETFs: Separately, Strategic Insight estimated that investors poured an additional $16 billion into US Exchange-Traded Funds (ETFs) in December. Flows were driven by equity ETFs, while bond ETFs (with the exception of high-yield bond ETFs) saw net outflows. December’s inflows marked a rise from the $7 billion in net inflows that US ETFs enjoyed in November. December also capped another strong year for ETFs, as full-year inflows to US ETFs totaled $109 billion – the fourth straight year that net inflows to ETFs topped $100 billion.

At the end of December, US ETF assets stood at a record $1.005 trillion – the first time that US ETF assets crossed the $1 trillion mark, and roughly 13% of the size of the $7.86 trillion long-term, open-end mutual fund market. “January often features net outflows from US ETFs because of tax maneuvers and investors’ portfolio rebalancing, but US ETF assets should hold at $1 trillion in February and continue their march toward $2 trillion,” said Loren Fox, senior research analyst at Strategic Insight. “In 2011, we expect more news in the non-traditional ETF front, including more demand for ‘alternative’ ETFs, and more launches of actively managed ETFs.”

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Strategic Insight, an Asset International company, is a leading research firm for the mutual fund and wealth management industry, providing clients with in-depth studies, consultation, and electronic decision support systems.