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Fund Flows And Performance: Can they be linked?

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

According to an article I saw in Investment News recently, investors were leaving actively managed funds in droves and apparently moving toward passive index funds.   

American Funds’ flagship fund, Growth Fund of America, which had peaked at about $202 billion in assets in 2007, lost more than $33 billion last year!   No other fund even came close to that.   Fidelity Investments’ funds came closest, with net total outflows of $28 billion.

Do investors chase performance, or do outflows affect performance?  What many investors don’t know – or maybe they do or are beginning to learn – is that since all investors’ money is pooled together, fund outflows can affect investors who are left behind.  

It’s simple logic, really:  When a fund declines in value and investors begin selling shares (chasing better performance elsewhere), the fund manager must sell-off positions in order to raise cash in order to meet redemption requests.  This can be a problem.  Most managers would rather be using cash to buy good companies at reduced prices; but, if they have to meet redemption requests, it hampers investment in potential opportunities!  It also works the other way:  It’s hard to put new money to work when it’s flowing in at market tops.  No wonder indexes seem to do better than the average manager.

American Funds’ Growth Fund of America is a good case in point.  Even as it lost $33 billion in outflows, it’s performance in 2011 ranked in the bottom 25th percentile of all large-cap growth funds, although much of the loss can be attributed to holding 18% of assets in foreign stocks, which, according to Morningstar analyst Kevin DcDevitt, is apparently double the category’s average.

Nevertheless, if you subtract the American Funds’ Growth Fund and its $33 billion of outflows from the equation, actively managed funds still trailed passive index funds by nearly $38 billion of net inflows, according to Morningstar data. Exchange-traded funds did even better, collecting $121 billion of inflows.

Who benefitted?  Apparently The Vanguard Group!  They took in $29.5 billion in mutual fund inflows last year, the most of any mutual fund family. American Funds family lost $81.5 billion.

Whether investing inside or outside of a tax-deferred retirement account, investors are wise to keep a sharp eye on costs.  It’s true that cost is a function of value – no one minds paying for value – but, it’s important not to pay excessively and to know what you’re paying for. 

Paying attention to share classes is a beginning.  If your funds have 12b-1 fees, the question has to be “Why?”  Is an alternative arrangement with greater transparency available?

Due-diligence begins at home.

Jim

Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Written by Jim Lorenzen, CFP®, AIF®

January 31, 2012 at 8:00 am