As mutual fund marketers and distributors try to discern where the growth areas will be in new fund product development and fund flows, they easily can be overwhelmed as they survey the current fund landscape. The number of mutual funds and ETFs has grown tremendously over the past two decades. Now there are over 12,000 different share classes of equity mutual funds and over 6,000 share classes of taxable bond funds. The fund industry, however, continues to create new products to diversify its asset base in hopes of generating additional revenue. Mutual fund marketing and distribution professionals, therefore, may need to narrow their focus in order to best place their efforts on some of the most compelling and growing segments for the remainder of 2014.

How Will the New Funds Invest?

In the upcoming months we can look for new mutual funds and ETFs that focus on income solutions to meet the growing number of retirees' thirst for income and that address their risk aversion after the gyrations of the equity markets over the last 15 years. Building on these risk-aversion and capital-preservation themes, we can also look for new funds that come with the stated goal of delivering consistent returns. Fund distributors should be prepared to think proactively about creating promotions and marketing collateral that incorporate not only income but emphasize total return throughout different market cycles. Those products will come in the alternative-investment space: absolute-return and market-neutral products or some variation that emphasizes event-driven outcomes. Net fund inflows to these classifications have been gaining momentum in recent months, particularly as market volatility has unexpectedly risen since the end of 2013.

Liquid alternative-investment funds and absolute-return products remain attractive growth segments, since a lot of them were unavailable to fund investors until recently. Investors find these products particularly appealing for their portfolio diversification benefits and their perceived ability to provide positive absolute returns in different market environments. This is an attractive characteristic, now that we appear to be seeing the end of the 30-year bull market in bonds. The staggering gyrations of the equity markets over the past 15 years also have contributed greatly to fund investors' desire for products that can deliver more predictable positive returns. Distributors will likely need to market these funds, or be prepared to encounter campaigns, with an emphasis on their uniqueness and potential to reduce portfolio volatility while increasing diversification.

Where Are the Fund Flows Going Now?

A noteworthy current trend for fund distributors to understand is that higher-dividend-paying mutual funds appear to have lost some of their appeal to fund investors thus far in 2014, with $1.8 billion net leaving Lipper's Equity Income Funds classification (excluding ETFs) for 2014 as of April 2. Lipper's Equity Income classification saw record net inflows of $21.0 billion move into the category for 2013 as interest rates remained close to historic lows. But fund investors, appearing to be concerned about the prospects for higher interest rates and having viewed the equity income segment as a bond-like substitute for yield, may now be considering other fixed income alternatives. Distributors may have marketing campaigns centered on the need for income but they will likely need to be flexible in the coming months as partly evidenced by this shift. As a result of such concerns alternatives such as unconstrained bond funds are attracting interest of late from fund investors. The unconstrained approach, and the flexible options it can create for an experienced fund manager adept at asset allocation, can potentially provide attractive total returns. This approach has strong appeal in the current extended low-yield environment against a backdrop of volatile equity market returns, where even the traditionally more conservative equity income category is subject to a rapid turnaround in the direction of flows. Neuberger Berman recently launched its Unconstrained Bond Fund (NUBAX) in February 2014, and it will be interesting to view in the coming months how a newly launched product that follows this objective will be positioned, distributed and marketed, particularly since it is anticipated more offerings are soon to come from other fund complexes.

Another segment that also bears watching for distributors is loan participation funds. This area has witnessed unprecedented growth over the past five years and now has a much higher asset base than it did in 2008. If the long end of the yield curve were to finally become relatively more attractive, it is conceivable an investor exodus from floating rate funds could occur and place the asset class in unchartered territory. That development may truly test the liquidity of the loan market.

Fund Strategies with a Tailwind

Indexing with a "twist" - smart-beta strategies - should continue to be promoted by fund companies as an alternative or middle ground to traditional indexing and active management. Smart-beta approaches are designed as alternatives to traditional market capitalization-weighted index investing, which can often have significant weightings in larger names. There are many different variations of smart-beta which will require greater investor education as marketing campaigns for them evolve. These strategies can be relatively straightforward but do not lend themselves to an "all in one" distribution solution.

Barry Fennell is a senior research analyst at Lipper.

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