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September Slump Cools Investor Expectations: Fund Flows in Q3 2020

While the COVID-19 pandemic drove both equity and fixed income lower in the first quarter of 2020, a broad recovery took hold in the second and third quarters. Similarly, mutual fund flows continue to move toward bonds in record numbers.

The chart below shows that through the end of Q3 2020, the S&P 500 Total Return (^SPXTR) was up 5.6% and the Bloomberg Barclays Global Aggregate (^BBGATR) added 5.7%. Earlier in the year, many speculated about the recovery’s “shape” and time frame—just two quarters later, the “check” or “swoosh-shaped” rebound seems to be sticking, even after the S&P came off its all-time high set in early September.

stock and bond market 2020 fund flows

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So how have investors responded to this sustained recovery? Has confidence been restored, or will the combination of a global pandemic and uncertainty surrounding the U.S. election hang over investors’ heads in Q4?

To answer these questions, we look to fund flows.

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 (or net issuances for ETFs) 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.

After record outflows of -$255 billion in February 2020, investors rushed back to bond mutual funds in force. July net flows topped $69 billion, also a record high, according to ICI data. Separately, U.S. equity mutual funds continued to lose assets, though their ETF counterparts strung together another month of net positive flows.

stock market inflows and outflows chart fund flows

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Mutual Fund Flows: Biggest Winners and Losers

Short and intermediate bond fund categories saw the most inflows in Q3 2020.

Uncertainty about the U.S. presidential election and winter-time pandemic response plans are seemingly driving this flight to safety. Intermediate Core Bond and Intermediate Core-Plus Bond mutual funds re-entered the spotlight after losing assets in Q2. Those categories attracted $45.3 billion and $32.6 billion in the third quarter, respectively.

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Noticeably absent from the table above: long-term bond products. With historically low interest rates, investors likely avoided long-term bonds as they are most price-sensitive to rising rates. For example, American Funds Bond Fund of America (ABNDX), Intermediate Core’s top fund of the quarter, currently has an effective duration of 5.9, while the duration for Vanguard’s Long-Term Investment Grade (VWETX) fund is 14.9.

Looking to mutual fund outflows, Money Market funds lost the most assets of any category in Q3 2020—$213 billion. Just last quarter, though, Money Markets had the most inflows of any category, adding more than $290 billion in assets, and still sit north of $770 billion year-to-date.

It appears that investors have become more comfortable with putting money to work amid uncertainty. However, it’s been a measured approach as four Large Cap Equity categories rounded out the five biggest losers of Q3.

mutual fund flows most outflows

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Notably, Large Growth mutual funds have lost more than $109 billion of assets over the last year despite growth equities’ continued outperformance (see performance table below).

ETF Flows: Biggest Winners and Losers

Similar to the pattern seen in mutual funds, Intermediate Core Bond ETFs added $15 billion assets in Q3 2020, the most of any ETF category. Close behind were Commodities Focused ETFs with inflows of $12.2 billion, most of which came early in the quarter.

etf net issuance flows most inflows

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Though just $10 billion of assets flowed into Large Blend ETFs in Q3, the $67 billion gained in the last twelve months illustrates the market’s preference for ETFs over mutual funds to gain equity exposure.

The quarter’s “biggest loser” category was Trading-Leveraged Equity ETFs—a clear indicator of more active traders pulling back the reins on risk. The S&P 500 reached 12% year-to-date gains in early September but quickly came off its new high, potentially due to setbacks in states’ reopening efforts or politically-induced uncertainty.

etf net issuance flows most outflows

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Active managers regain ground on Passive funds in battle for assets

After the massive drawdown of Q1, investors have turned to active managers in search of both stability and cutting edge strategies.

Active ETFs added $15.3 billion assets in the third quarter, nearly half of their $36 billion year-to-date inflows. Most popular was the ARK Innovation ETF (ARKK), which seeks to invest in “disruptive innovators,” like those that have thrived amid the covid-19 pandemic.

While active mutual funds added $36 billion in assets last quarter, it’s a marginal gain compared to net negative flows of $1.2 trillion in 2020.

active passive mutual fund flows

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Flows into passive funds mirrored the active managers, losing assets in Q3 but still with significant additions in the calendar year. Passive ETFs have added $231.9 billion of assets year-to-date, and yet the Invesco QQQ Trust (QQQ) and Vanguard’s S&P 500 ETF (VOO) deviated in terms of flows.

QQQ added $6.6 billion of assets and VOO lost $7.4 billion. The market clearly prefers the tech-heavy Nasdaq index to the more diversified VOO, which tracks the S&P 500 index.

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Equity style fund flows and performance

The table below shows a summation of mutual fund flows and ETF net issuances, plus average category performance for the nine equity style boxes.

Equity style box fund categories lost assets across the board in Q3, with Large Growth mutual funds and ETFs posting net outflows of $84 billion over the last year. In the quarter’s last month, September, Large Blend, Small Value and Small Growth were the hot categories with marginally positive net flows.

stock market inflows outflows fund flows

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The three growth styles led performance in every period shown, outperforming value and blend funds by large margins over the last year, and proving most resilient during September’s downturn, too.

Growth’s combination of strong performance and large negative flows in 2020 is interesting and the reason why is difficult to pin down. Perhaps investors are taking gains off the table as large, mostly technology companies run higher and market breadth narrows?

As the market rally cools, investors set mixed expectations

The goal of analyzing fund flows is to uncover insights about investor sentiment. So what does the above data for Q3 2020 reveal?

After hemorrhaging assets in March 2020, bond mutual funds have bounced right back as investors show general bearishness. That said, net positive flows into the likes of Large Blend ETFs and Foreign Large Blend ETFs, plus Small Value and Small Growth funds, indicate some level of risk-taking activity.

More states are rolling back reopening efforts amid spikes in daily coronavirus cases, and the presidential election introduces new unknowns into investors’ forecasts. In response, asset flows in the third quarter were mixed but measured across fixed income and equities.

Some of those unknowns may come into view in the fourth quarter of 2020, but whether they are good news or bad news for investors remains to be seen.

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