John Rogers' Ariel Fund June 2015 Commentary – Flows!VW Staff
John Rogers' Ariel Fund commentary for the month ended June 30, 2015.
Last month, we studied year-to-date returns, and this month, we will comment on year-to-date flows. We see returns and flows as two different tools for measuring investment sentiment and think using them in combination is superior to depending solely on one. Recall that in examining U.S. stock returns last month, we noted returns were positive across the board, with growth outperforming value. To us that suggests optimism and an embracing of risk for U.S. equity investors.
We now turn to asset flows in mutual funds. Last year when we examined 56 categories in the taxable bond, U.S. equity and international equity groups, we saw a fairly clear picture. Investors were hunting for yield, especially in bonds, and seeking safety in equity categories. They were avoiding growth fare and aggressive international investments. All in, we saw broad caution in the first half of 2014. The picture is different and a bit more cloudy this year.
John Rogers: Categories with the biggest dollar inflows
Below are the 15 categories with the biggest dollar inflows, with boldface indicating a big percentage jump in assets.
The most obvious trend that appears is broad. Of the top 15 categories by flow, six are international stock, six are bond, one is sector, and only two are U.S. equity. Moreover, the two U.S. equity categories are large blend and mid-cap blend, home to many index funds. The multi-year rotation toward foreign stocks and away from U.S. stocks continues. In bonds, the preference is less straightforward but discernable. Investors heavily bought bond categories that Morningstar describes as having medium- to-low credit quality and moderate- to-extensive interest rate sensitivity. That signals risk-seeking rather than risk aversion, and for the most part, suggests the ongoing hunt for high yields in a low-yield environment continues. The push into high-yield and corporate bonds is especially notable and to our minds, a sign of potential danger, given their tight spreads to government bonds.
John Rogers: Mutual funds with the heaviest outflows
Now we turn to the 15 types of mutual funds with the heaviest outflows.
One clear movement we see here is the counterpart to inflows: a big investor preference for international equity over U.S. equity. That is, we see five categories of U.S. equity funds in heavy outflows and just one international category (the one that happens to contain a significant stake in U.S. equity, by the way). Also, seven bond fund categories are in heavy outflows. Five of these seven have high credit quality or limited maturity. That is, in one respect or another, they are fairly conservative and boast correspondingly low yields. Short-term bond categories took the biggest beating. This is somewhat worrisome, since those categories provide the most asset protection in a rising rate environment, which conventional wisdom argues is on the horizon, given the widely expected rate hike from the U.S Federal Reserve Bank.
On the whole, the trends make us a bit nervous, but we do not see cause for alarm. As we have noted elsewhere, we are in the seventh year of an equity bull market, and valuations are fairly high. Moreover, bonds seem very expensive and likely to suffer sooner rather than later when rates rise. That argues for risk aversion, but we see risk-seeking. Again, the hunt for yield has become perilous. On the other hand, with one notable exception-high-yield bonds-investors are not heavily piling into the most risky types of mutual funds. In addition, because U.S. investors have historically been overweight domestic equity and underweight international, a broad and gradual rotation is reasonable. All told, investors truing up their allocations and sticking to a solid game plan are likely in good shape. Those using trailing returns to guide forward action are courting risk. We remind our investors the words of Warren Buffett: “Be fearful when others are greedy and greedy when others are fearful.”
The opinions expressed are current as of the date of this commentary but are subject to change. The details offered in this commentary do not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security. Past performance is no guarantee of future results. Investing in equity stocks is more risky and subject to the volatility of the markets. Investing in micro-, small and mid-size companies is more risky and more volatile than investing in large companies.
Investments in foreign securities may underperform and may be more volatile than comparable U.S. stocks because of the risks involving foreign economies and markets, foreign political systems, foreign regulatory standards, foreign currencies and taxes. The use of currency derivatives and exchange-traded funds (ETFs) may increase investment losses and expenses and create more volatility. Investments in emerging markets present additional risks, such as difficulties in selling on a timely basis and at an acceptable price.
Bonds are fixed income securities in that at the time of the purchase of a bond, the amount of income and the timing of the payments are known. Risks of bonds include credit risk and interest rate risk, both of which may affect a bond’s investment value by resulting in lower bond prices or an eventual decrease in income. Treasury bonds are issued by the government of the United States. Payment of principal and interest is guaranteed by the full faith and credit of the U.S. government, and interest earned is exempt from state and local taxes.
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