A lackluster December in mutual fund sales closed the curtain on a year that wasn't overly dramatic for the industry, according to fund tracker Lipper of New York. While the S&P 500 rallied by 3.4% in the final month to help deliver a solid, 11.5% gain for the average domestic equity fund in 2004, fund flows sputtered in December as investors turned their attention to the holidays.
All told, funds lost $34 billion during the year. Equity funds took in $220 billion, but bond funds saw $14 billion in net outflows and money funds saw $240 billion drain away. The good news for the industry, however, noted Lipper Senior Analyst Don Cassidy, was the strong flow into equity funds, marking a "clear improvement in revenue mix" because of the funds' higher fees.
"Estimated inflows into equity funds from retirement-plan accounts in the workplace probably accounted for about 60% of the $220 billion overall inflows into such funds, so it is clear that mutual fund investors were by no means overly excited about the market in terms of its driving them to write lots of checks into their taxable accounts," Cassidy said.
Cassidy cited a prolonged period of frustrating sideways and slightly downward price trend as a reason for investor reluctance. For example, flows were fairly strong in those months when stock prices were rising most sharply. In fact, he noted, January 2004 enjoyed a new all-time single-month record for flows to equity funds, narrowly beating the prior peak set in February 2000.
Net flows into red-hot exchange-traded funds were about $50 billion in 2004. While they continued to gain market share, they account for less than 3% of conventional fund industry totals and a whisker over 4% of non-money fund totals.
Due to their "clean reputation, ETFs benefited to some degree from switching from funds as a response to the trading scandal, [as well as] from strong marketing and rising awareness, from their low expense ratios and from their all-day transacting ability," Cassidy said.
By comparison, conventional index funds enjoyed net inflows of $62 billion in 2004. Excluding January, when older-style index funds had a very large inflow, the two competing types ran essentially a cumulative dead heat in flows for the subsequent 11 months, Cassidy observed.
Looking back on the year, Cassidy expressed a degree of satisfaction over the industry's performance in the face of external events. Impact from the trading scandal persisted, he added, but investors returned to equity funds because the bull market continued. Net inflows, however, relied heavily on the strength of workplace retirement plans.
"The bad news is that investors have not been buying funds in large amounts based upon current decisions, despite a sanguine market climate," Cassidy said. "The good news is that they yet show no signs of over-exuberance, although a few small pockets of strong inflows might raise concern.
And while ETFs, separately managed accounts and hedge funds continue to pose challenges, the bulk of middle-American households still choose conventional mutual funds as their primary investment vehicle. As such, Cassidy is appealing to the industry to further educate the general public on the benefits of consistent investing, rather than to buy high and sell low. The upcoming debate over the privatization of Social Security could provide the appropriate platform, he said.
"Although we doubt the fund business will get a piece of the action in the near term, it can do a major, visible public service by raising its education efforts even in the absence of prospective immediate self-interest," Cassidy said.
A Cautionary Tale
In December, investors added an estimated $12.4 billion to equity funds, which was roughly half the inflow they enjoyed during the previous month's post-election enthusiasm. Bond funds bled $2 billion and money-market funds drained $5.5 billion.
"Even allowing for the usual holiday lull in net flows, the results were a bit disappointing considering short-term performance," Cassidy said. "We continue to see strong selection bias toward safe-feeling fund types and little overall sustained enthusiasm."
U.S. diversified equity funds, which have about 64% of total equity fund assets, were also on trend in December, posting small net inflows of less than $1 billion. Sector funds continued to reflect investors' lack of confidence about making rifle-shot choices, Cassidy said, and witnessed an outflow of $1.7 billion, despite inflows to real estate and natural resource funds.
"Investors could hardly be described as excited or manic," Cassidy commented. "With $6.2 billion of net inflows, the mixed-equity fund types took in half the overall equity funds' flows as current income in hand retained its strong hold on taste."
World equity funds had about $6.8 billion of inflows for December, led by broadly international rather than local choices, further reflecting investor wariness over the weak dollar. Not surprisingly, the funds stole the show for the year, too, with total inflows of about $83 billion. Flows in narrow areas or single countries were rare again in December, but gains were largest in European region funds, which accepted $300 million. The China region was next, with $250 million added.
Sector funds bled $1.7 billion in December, led by a $1.2 billion drain in science and technology, according to Lipper. Real estate and natural resources funds were big winners for the month and took in $4.7 billion each for the year.
Mixed-equity funds, meanwhile, also enjoyed a strong December, racking up $6 billion in net intake, while funds based on the S&P 500 captured a modest $200 billion for the month and just $11.3 billion for the year.
On the fixed-income side, December bond fund flows were mildly negative at $2 billion. Reflecting the trend of previous months, municipal bond fund flows were proportionally more negative then those in taxable bond funds. While assets in muni bond funds are only about 38% as large as those in taxable funds, Cassidy said, the outflows were essentially equal at $1 billion each.
"Following tax bracket cuts and the enactment of favorable tax rates on dividends, muni bond income is now less highly sought at the margin," he added. "And several of the most attractive and sophisticated bond types in a potentially rising rate environment are found on the taxable side of the arena."
TIPS bond funds saw inflows of $600 million in December, while flows into corporate bond funds were positive and flows to Treasury/government funds were neutral, indicating both yield seeking and expectations of economic expansion, Cassidy said.
"One seeming major anomaly was an outflow of nearly $1.5 billion in high-yield bond funds. These had seen mixed and volatile trends all during the year," he noted.
For the year, bond fund flows were mildly negative at about $14 billion.
Money market funds had an estimated net outflow of $5.5 billion in December and about $240 billion for the year, a mere 2% smaller than the record outflow they suffered in 2003 and five times what they lost the previous year. Lipper attributed the continuing drain from money funds to low interest rates and improvement in the stock market.