Cash flowing into mutual funds — particularly bond funds — at a record pace is a welcome turn of events for the fund industry, but it could end up hurting fund companies to the extent that flows are the result of investors' chasing returns.
Cash flowing into mutual funds — particularly bond funds — at a record pace is a welcome turn of events for the fund industry, but it could end up hurting fund companies to the extent that flows are the result of investors' chasing returns.
During the third quarter, in-vestors poured $144.7 billion into funds, taking the year-to-date total to $273.2 billion, according to Morningstar Inc.
That puts the fund industry on track to break the 1997 record of $300 billion in net new-cash flow, said Michael Evans, president of the Fuse Research Network LLC, an industry consultant.
During the third quarter of 2008, investors pulled $69.4 billion more out of long-term mutual funds than they put in, resulting in a positive but declining year-to-date cash flow of $23.1 billion. Outflows sped up after the third quarter, resulting in a total net outflow of $156.8 billion for the year.
Bond funds are receiving most of the cash. They took in $123.7 billion in this year's third quarter, bringing the year-to-date total to $254.6 billion, according to Morningstar.
On the surface, such strong flows are great news for fund companies — albeit tempered somewhat by the fact that bond funds are less profitable than equity funds.
But they need to be careful.
“It's a difficult predicament for investment managers because on the one hand, new monies would greatly offset the pain of outflows last year, yet firms need to consider their fiduciary duties to both existing and new clients,” said Benjamin Poor, a director with Cerulli Associates Inc.
For example, most industry experts believe that heavy borrowing by the government and inflationary policies eventually will drive up interest rates — and push bond prices down.
BAD TIMING?
Investors who rushed into bond funds because they were chasing returns will be hit hardest, having gotten in at the top of the market.
And while investors make the ultimate decision to invest, they will almost certainly blame the fund company for their misfortune, Mr. Evans said.
Pacific Investment Management Co. LLC stands to take the hardest hit if the bond market heads south.
Its Pimco Total Return Fund (PTTAX) has been the biggest beneficiary of bond flows.
Year-to-date through September, the fund had taken in a net $36.3 billion, giving it $185.7 billion in total assets, according to Morningstar.
Other Pimco funds also were winners.
Year-to-date through the end of the third quarter, the Pimco Commodity Real Return Fund (PCRAX) gathered $5.1 billion, the Pimco Short-Term Fund (PSHAX) saw inflows of $4.7 billion, and the Pimco Investment Grade Corporate Fund (PBDAX) and the Pimco Low Duration Fund (PTLAX) each took in $3.3 billion, according to Morningstar.
Given recent above-average returns experienced by all those funds, it is likely that at least some of the new money they took in was the result of investors' chasing performance, industry experts said.
Pimco's response has been to step up efforts to educate investors.
For example, Pimco is in the midst of a 20-city road tour in an effort to educate investors about the “new normal” of slower economic growth and lower investment returns, said John Short, head of the firm's institutional business development group.
Pimco hopes investors will take such information and make in-formed decisions, he said.
"TIMELY INFORMATION'
It is a similar approach to the one taken by Invesco Aim Management Group Inc.
The unit of Invesco Ltd. in September 2008 launched on its website a feature called Investment Perspectives that provides investment commentary to investors, said David Gluch, senior director and head of product management at Invesco Aim.
In April, he said, the unit launched an educational effort called Rethinking Risk, through which it provides financial advisers with its thoughts about how the markets and portfolio construction have changed.
“We want to provide [investors] with timely information. We want to help educate them better to make better decisions,” Mr. Gluch said.
“We're not trying to steer them away from investing in any particular investment; we're just providing them with a frame of reference.”
Such efforts are laudable, said Sonya Morris, a senior mutual fund analyst at Morningstar.
“I think those educational efforts are important,” she said. “We like to see fund companies do that.”
But in some cases, more-drastic measures are required.
For example, The Vanguard Group Inc. responded to inflows into its Vanguard Capital Value Fund (VCVLX) by closing the $742 million fund to new shareholder accounts this month.
The fund is Vanguard's top performer thus far this year, with a total return of 68.5% through the first nine months.
Assets in the fund have more than tripled since the end of February as a result of market appreciation and strong cash inflows.
Vanguard decided to close the fund to new investors to protect existing shareholders from higher transaction costs, and to protect prospective investors from getting burned by chasing returns, said Dan Newhall, a principal for portfolio review at the company.
“We're always trying to really look out for the interest of existing and prospective shareholders,” he said.
Despite historic inflows, however, other fund companies are unlikely to follow Vanguard's lead.
Fund companies — sometimes very reluctantly — will close a fund when it becomes so big that it becomes difficult for a manager to put assets to work efficiently.
But when it comes to closing a fund to prevent investors from chasing returns, most are of the opinion of Mr. Gluch.
It is impossible to know whether an investor is chasing returns or making a wise investment decision, he said.
EDUCATIONAL EFFORTS
Given that uncertainty, it is much better to educate investors about the dangers of chasing returns, Mr. Gluch said.
Although a fund company should always do what is best for its current shareholders, closing a fund to protect prospective investors from themselves isn't a fund company's job, said Micah Porter, president of Minerva Planning Group Inc., which has $60 million under management
“I think they shouldn't attempt to manage the investor's bad habits,” he said.
E-mail David Hoffman at dhoffman@investmentnews.com.
