Quest for income: Q1 fund flows favour alternative sources
It has been a challenging start to the year for the global mutual funds industry, buffeted as it was by tough market conditions and increasing risk aversion among investors.
After almost uninterrupted growth between 2011 and 2015, global mutual fund industry showed some weakness in the first quarter of 2016, with assets under management (AUM) down 3.2% compared to year-end 2015[1]. Investors’ concerns regarding a Chinese “hard landing,” slowing global economic growth and the risks of unforeseen consequences of extraordinary central bank policies drove the sell-off in financial markets, particularly in January and February.
With those market conditions as backdrop, mutual fund asset values showed declines, particularly for funds more exposed to equity markets as well as more equity-sensitive credit instruments. At the same time, investors reacted by shifting assets away from those funds more exposed to market volatility, to, on the one hand, asset classes they perceived to be “safer” (i.e. higher-quality bonds), and on the other hand, funds targeting low correlations with traditional asset classes, such as liquid alternatives.
In terms of fixed income, USD bond funds were among those with the strongest inflows, as US domiciled investors turned back to the category, as expectations for an imminent further tightening by the US Federal Reserve declined. Alternative solutions, remained very popular as during 2015[2], being regarded by investors as an “alternative” way to further diversify portfolio risk. Liquid alternative and absolute return funds were favored especially by European investors, with absolute return multi-asset and alternative multi-strategy getting the largest chunk of the inflows. Some interest was expressed for funds using long/short and market neutral strategies as well.
Global mutual fund industry net flows in 1Q16
Source: Strategic Insight Simfund database, as of May 9, 2016.
Active equity and multi-asset funds, were among the hardest-hit by market turbulence, with overall outflows of around €100bn globally. US equity funds and multi-asset flexible solutions were the two specific categories bleeding the most assets, with the most negative sales coming from US investors for the former, and from Chinese investors as regards the latter. Interestingly, there was a notable bright spot in Global equities, which ended the quarter with some positive net flows, most of which came from the US.
The negative sentiment on the part of investors was particularly strong in January, with mutual funds suffering net redemptions for €117bn. In the following 2 months, however, the stabilization of financial markets, on the back of prompt interventions by Central Banks, combined with more reassuring global economic data, helped the industry regain ground, ending the quarter with outflows of just €11bn, 0.04% of total assets.
We believe that some of the characteristics of Q1’s flows will likely continue for most of the year, with investors on the sidelines looking for alternative sources of income with a balance of risk/reward.
We are living in an unprecedented period of low growth and low inflation with the consequence that expected returns for most asset classes will be lower than in the past. At the same time, multiple sources of volatility will likely continue to affect investor sentiment, such as the prospective Brexit referendum, tense electoral seasons in Europe and in US, the uncertain timing of Central Banks’ exit strategy and overall economic conditions that remain fragile.
As the outlook for the economy and financial market continues to be extremely uncertain, we believe that investors will continue to search for alternative source of diversification of their portfolios, to try to limit the downside during phases of market turmoil, while pursuing additional returns. Therefore, we believe the positive trend we have seen in favor of liquid alternatives in Q1 would continue in coming quarters.
In addition, the search of income will continue to be a key ongoing dynamic, as traditional income sources – primarily government bonds – are not able to provide adequate income (almost 80% of government bonds in Europe trade at yields below 1%[3]). This quest for income will likely require investors to broader their fixed income exposures, prompting many to move into the multi-asset space.
The multi-asset setback in Q1, was in our view, the result of a tactical move to reposition portfolios during a period of acute turmoil, rather than a strategic reversal of the trend that saw these funds draw great demand by investors in 2015. We note that most of the outflows in 1Q16 were recorded in China, hit by strong redemptions after the record sales of 2015. In Europe, on the other hand, multi-asset products ended the quarter with just slightly negative flows, with investors remaining in a wait-and-see attitude. We believe that a new generation of multi-asset products, focus on diversifying among various components, combined with enhanced techniques of risk management seeking to limit portfolio drawdown will be back among investors’ preference in the remaining part of the year.
A few final words on equities. In Q1 the industry saw continued demand for passive products. This trend will likely continue, with passive solutions growing at the expense of active solutions – especially those that are unconvincingly differentiated from their benchmarks. However, with less directional market trends ahead, truly active managers that are able to seek out additional returns through downside protection and a high conviction approach could well be back in favor by investors.
[1] The data include all mutual funds, active and passive (including ETF), but exclude FoFs, in order to avoid duplications of assets and flows. Source Strategic Insight Simfund database.
[2] Source: Strategic Insight Simfund database. In 2015 alternative solutions (including absolute return funds) gathered inflows for over €100bn globally.
[3] Source: Bloomberg, data as of April 30, 2016.
Gabriel Altbach is Pioneer’s head of Global Strategy and Marketing
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