Before we can position ourselves for success in the new year, we must assess who won and who lost last year.
The fund industry returned to good health in 2013. Long-term mutual fund and ETF flows totaled $453 billion. Combined with market appreciation, industry assets hit a record $12.6 trillion, excluding money market funds. A clear signal of the return of investor confidence was the 33% return for the S&P 500, along with a collapse in gold prices. Gold is often seen as a disaster hedge that is held out of fear. Investor confidence in the economic recovery pushed interest rates higher in anticipation of Federal Reserve action, sparking outflows from core bond funds and a rotation into equities.
Nearly $1 out of every $4 invested went to Vanguard in 2013, which boasted the top three asset gathering funds. The firm's success is driven by several factors. Its mutual form of ownership encourages an at-cost pricing structure, undercutting the competition. Sales distribution through the direct and fee based advisor channels has clearly won out over load based, or proprietary sales methods. Finally, the funds themselves are typically core portfolio building blocks, suitable for the bulk of investor assets. The funds are easy to use and are unlikely to be found at the bottom of any peer ranking. Although not the inventor of the ETF, Vanguard continues to take significant share from iShares and State Street.
The secular trend toward passive investing, coupled with strong equity performance, helped Vanguard Total Stock Market Index fund overtake PIMCO Total Return as the world's largest. Passive U.S. equity fund flows continued to outpace active flows to the tune of $156 billion. But there is hope for active funds. Outflows from the funds moderated last year to only $12 billion from the prior year's $131 billion outflow.
Alternatives had the strongest organic growth rate of any category group. Investors displayed their preference for the liquidity, transparency, and lower fees offered by alternatives within the 1940 Investment Company Act structure. Asset managers are happy to oblige with more offerings, but flows here are hit or miss. MainStay Marketfield fund alone took in $13 billion of the group's $49 billion of inflows. Developed markets finally get some respect. After years of ceding flows to emerging markets, developed markets took more flows in 2013. A recovering European economy and Abenomics in Japan boosted returns for developed markets while emerging markets suffered from the apparent end of the commodities bull cycle and liquidity concerns related to the Federal Reserve's plan to taper stimulus.
Active ETFs appear on the cusp of relevance. For years, fund managers have been just dipping their toes in the pool, waiting for someone to jump in and tell them that the water is fine. Every major fund manager is making plans for active ETFs. State Street announced plans to partner with MFS, one of the few firms that has been able to raise assets in active mutual funds. Eaton Vance laid out plans for non-transparent active ETFs. Although not active, Fidelity finally launched a series of sector ETFs, choosing to partner with iShares while JPMorgan is putting the finishing touches on its own lineup of ETFs.
Even shy advisors have a good excuse to pick up the phone and call clients, since the divergence between stock and bond returns knocked allocations out of balance. With equity markets looking expensive and Treasury bond yields closer to normal, now seems like an opportune time to rebalance. Asset managers should be encouraging these conversations and provide advisors with appropriate education materials.
Not everyone had a good year. Among the losers were risk averse investors who have sat on the sidelines since the financial crisis, avoiding equities. Worse yet, some investors piled into gold only after gold prices were bid up following the metal's strong performance in 2009 and in anticipation of Q.E. induced inflation. The fear bubble popped in 2013, resulting in the worst single year return for gold since 1981.
PIMCO had a particularly hard year. The firm has been developing its offerings outside of fixed income in anticipation of the shift to equities, yet these funds failed to attract assets. PIMCO seemed to have trouble gaining assets even in fixed income categories that had inflows, such as high yield. One fund that should have been a bright spot, PIMCO Unconstrained Bond, had disappointing performance and Bill Gross took over management of the fund late in the year.
Municipal bond fund investors were hit by a one-two punch of rising interest rates and credit concerns. It is hard to build trust when you are trying to explain to investors why their single state municipal bond funds had exposure to Puerto Rico.
After the events such as the financial crisis, the Bernie Madoff scandal and the flash crash, investors began to lose faith in the asset management industry. Strong returns and strong flows in 2013 proved that the industry is successfully rebuilding trust.
Mike Rawson is a fund analyst at Morningstar.