Mutual Funds

Many investors appreciate the benefit of covered-call strategies, but we wonder how many truly understand the opportunity costs of buy-write funds over time—or under differing conditions. On the surface, these approaches are simple, but they have complicated payoff patterns relative to stock and bond funds.

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The fourth quarter of 2022 saw broadly positive equity-market performance with the S&P 500 returning +7.6%, the Russell 1000 Mid Cap Index at +7.2%, and the Russell 2000 Small Cap Index gaining 6.2%. Strong returns usually present a headwind for active managers, but the fourth quarter proved productive for actively managed funds.

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Relative performance of active and passive mutual funds is one of the leading story lines in our industry, with passive’s recent advantage leading some to argue that it will be the dominant style forevermore. We disagree, and believe that the active/passive relationship has been, and always will be, cyclical.

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When the “most hated bull market on record” finally suffers a steep decline, it’s reasonable to expect that the hatred might evolve into true revulsion.

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The “cash on the sidelines” is a Supply/Demand argument that we’ve struggled with even in the most bullish of times; every purchase of a security is matched with a sale. But even taking the argument at face value, current holdings of retail investors and mutual fund managers suggest that the cash left the sidelines long ago.

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Both equity and bond categories set all-time nominal net cash flow records.

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Year-to-date, equity funds are cash on par with those of the 2000 tech bubble, while bond mutual funds are experiencing net cash outflows for the first time in a decade.

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Funds of funds, particularly target date funds, are growing rapidly and are now large enough to have a measurable impact on underlying fund flow trends.

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In this report we take an in-depth look at the evolution of the industry, particularly the U.S. mutual fund industry, to help understand how some fund flow trends are more of an indication of evolving investor preferences instead of an indication of retail investor sentiment toward a particular asset class.

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Asset allocation portfolios continue to hold big positions in Emerging Markets. Jun Zhu presents an initial study exploring the use of Emerging Market Closed End Funds historical premium/discount levels as a predictor of future Emerging Market performance.

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Get out in front of the lemmings. We expect to ultimately see bond funds reverse now that performance has been lagging the stock market. But where will the money go? Our best guess is that it flows to Emerging Country Equities….once again chasing strong performance.

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This month’s “Of Special Interest” section looks at six trends from the Supply/Demand front. Key to several of these trends is that investors chase performance: still seeing big inflows into bond funds, with big outflows from retail money market funds.

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Starting to see some modest inflow into U.S. focus equity mutual funds, which is a stock market positive.

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The numbers continue to be strong. At this point, we attribute the strong flow to a combination of seasonals, and pent up demand.

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Public does not yet seem to phased by the mutual fund scandals as November marked the ninth consecutive month of net inflow to U.S. focus mutual funds, totaling $133 billion of net inflow.

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Thoughts and commentary regarding the groups in our Select Industries Portfolio, the Mutual Fund Timing scandal, NASD Margin Debt and deficit worries.

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The important role of cash levels in today’s mutual funds.

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Estimate outflow of $20 billion in June, largest redemption month since Sept 01…..Not yet panic mode as this only represents 0.7% of total U.S. equity fund assets.

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DALBAR study shows average investor missed out on 17-year bull market performance of 1984-2000.

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“Record” outflow only 10th highest as a percent of Equity Fund  assets. But, as a percent of stock market capitalization, September net outflow was about on par with October 1987.

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