Asset Managers - July 21, 2020
Where Are Investors Placing Recovery Bets? Reviewing Fund Flows in Q2 2020
In the first quarter of 2020, the covid-19 pandemic impacted both equity and fixed income markets, with the S&P 500 Total Return (^SPXTR) down 19.6% and the Bloomberg Barclays US Aggregate (^BBUSATR) 3.2% higher through the end of Q1.
However, it’s been a different narrative since the market bottomed-out in the final weeks of March. In Q2, the rising tide—in the forms of government stimulus and covid-19 vaccine breakthroughs—has lifted all boats. Many were hesitant to bet on a “v-shaped” recovery, but the chart below illustrates that as of 2020’s halfway mark, major equity and bond indices were nearing or at their all-time highs.
In response to the v-shaped rally, plenty of market commentators have warned about frothy valuations and historically poor economic data. When using fund flows as a risk barometer, investors are heeding those warnings.
Even despite the broad market recovery, fund investors became relatively more risk-off throughout the second quarter, moving their money away from equities and into fixed income mutual funds and exchange traded funds (ETFs).
Fund flows are the net cash inflow into a fund (purchases) or net outflow from a fund (redemptions). Irrespective of fund performance, when a mutual fund or ETF has positive fund flows in a given period, that fund’s managers then have more cash to buy more holdings. The opposite is also true: as fund holders sell shares, fund managers sell out of positions and use the cash to pay redemptions.
This means that fund flow data can indicate higher or lower demand for different asset types, depending on which funds and categories have relatively large inflows or outflows.
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Top mutual fund inflows and outflows
Money markets and fixed income dominated the top five mutual fund categories of Q2 2020.
It’s likely that investors are moving to Money Market and Intermediate Core Bond funds, which collected $290 billion and $35.5 billion over the quarter, respectively, as hedges against the stock market’s historically speedy recovery. That said, Money Markets’ $130 billion June outflow could indicate that sentiment shifted late in the quarter.
Also cracking the top five with $31.7 billion of inflows is the High Yield Bond category—when the Federal Funds Rate was lowered to zero and treasuries became relatively more expensive, fixed income investors became starved for yield.
While fixed income funds saw the most purchases in the second quarter, large cap equity funds suffered from the most redemptions.
Investors moved $55 billion out of Large Blend mutual funds in Q2. Other categories with the most outflows include both US-based and foreign equities, with Foreign Large Blend’s $17 billion outflow and Large Value’s $12.5 billion outflow being most noteworthy.
Noticeably absent from the most outflows list are growth fund categories. Growth stocks have outperformed their value counterparts both before and after the covid-19 crash, and investors seem to be holding on to those funds for now (more on growth funds in the equity style section below).
Top ETF inflows and outflows
The second quarter’s top and bottom ETF categories are largely similar to those seen in mutual funds.
Corporate Bond ETFs saw a $23 billion net inflow in Q2, likely another yield-chasing move by bond investors, while Commodities ETFs pulled in just more than $22 billion. The rest of the top five inflows were similarly fixed income-focused categories.
Looking at ETF outflows, the Foreign Large Blend category led the pack with $11 billion net redemptions in the quarter. Despite $4.8 billion in net outflows throughout Q2, Diversified Emerging Markets funds received $1.4 billion of investors’ money in June as both small caps and emerging markets have outperformed over the last few weeks.
Although large cap ETFs saw the most outflows in Q2 2020, both the Foreign Large Blend and Large Value categories are net positive over the last year.
Equity style fund flows and performance
The table below shows a summation of mutual fund and ETF fund flows, plus average category performance for the nine equity style boxes.
The only equity style box category with net positive flows in Q2 was Large Growth, bringing in $11.9 billion over the three month period. Large Blend and Large Value saw the most outflows, $52.6 billion and $15.7 billion, respectively.
In terms of performance, the recent resurgence of small cap equities is evident by outsized returns in June and the whole of Q2. On a year-to-date basis, only Large Growth, Mid-Cap Growth and Small Growth have garnered positive returns for investors.
“Cautious optimism” is easier said than done
The goal of analyzing fund flows is to uncover insights about investor sentiment. So what does the above data for Q2 2020 reveal?
Likely reacting to the S&P 500’s 20.5% climb in the second quarter, investors seem to have taken some equity gains off of the table and are hedging with fixed income funds. The move is in line with the latest conservative rhetoric that the stock market is overheated.
“Cautious optimism” has been a frequently relied on phrase since the rally in equities began, but the mindset is easier said than achieved. Going forward, investors must consider the insights from fund flows, a surging equity market, poor but steadily recovering economic data, and covid-19 case spikes when making decisions about their investments.
Ingesting and understanding all that information is no small feat, but with a global pandemic and teetering US economy, staying informed and incorporating new data points into your investment strategy is paramount.
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