January 5, 2018

Changing Trends in Mutual Fund and ETF Flows for 2017

by Tom Roseen.

Thomson Reuters Lipper’s preliminary 2017 fund-flows numbers show fund investors (including those of conventional mutual funds and ETFs) injected a net $528.4 billion into the funds business—$144.8 billion into equity funds, $286.5 billion into taxable bond funds, $25.6 billion into municipal bond funds, and $71.5 billion into money market funds.

A deeper dive into the numbers showed a fund-flows dichotomy between mutual fund investors and authorized participants (APs, the market makers responsible for creating and destroying ETF shares and the only source of ETF flows) for the year. While the average equity fund returned an eye-popping 20.38% (the strongest one-year return since 2013), mutual fund (ex-ETF) investors were net redeemers of equity funds, withdrawing some $120.7 billion.

That headline number was a bit misleading, however. Mutual fund (ex-ETF) investors were net purchasers of nondomestic equity funds, injecting $45.5 billion, while being net redeemers of domestic equity funds (-$166.2 billion). While returns might explain some of the discrepancy between the two groups—domestic equity funds on average returned 18.27% for 2017, whereas nondomestic equity funds posted a very strong 28.53% return for the same period—it doesn’t explain the whole story.

On the domestic equity side of the equation investors shunned large-cap mutual funds, withdrawing $72.7 billion—accounting for almost half the net redemptions from domestic equity mutual funds, despite large-cap funds posting a very handsome 22.44% for the year. We can surmise that some of the net redemptions went back into low-cost passively managed vehicles, in particular, ETFs. However, the other trend may have been that many Baby Boomers actually reallocated a portion of their core-and-satellite portfolios (where, over the last decade or so, large-cap funds had become a hefty portion of their diversified portfolios) into other asset classes: world equity funds, taxable bond funds, municipal bond funds, and to a lesser extent money market funds.

Even though the Federal Reserve Board hiked its key lending rate three times in 2017 and is telegraphing another three hikes in 2018 (which could weigh on bond fund returns), mutual fund investors continued to embrace fixed income funds, injecting $184.4 billion into taxable bond funds for 2017. Investors’ search for both yield and a modicum of safety relative to equities continued as many Baby Boomers headed into retirement.

Shrugging off concerns of what some market pundits were calling a frothy equity market, in 2017 authorized participants provided the inventory for retail investors to move some of their mutual fund assets to ETFs by fulfilling a demand for low-cost passively managed equity fund alternatives. For 2017 APs injected some $265.5 billion net into equity ETFs, split almost equally between domestic (+$138.9 billion) and nondomestic (+$126.7 billion) equity ETFs. They were net purchasers of taxable bond ETFs as well, injecting some $101.5 billion.

As we head into 2018, we’ll see if this trend toward mutual fund “disintermediation” continues or if actively managed funds can again attract investors back into the conventional funds business.

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