Mutual fund flows were mixed in a volatile first quarter of 2016. The Federal Reserve’s decision to reduce the number of interest rate hikes planned for the year led to a reversal in bond fund flows, while commodities and alternative investments gained traction. In the equity markets, investors have favored international equities over U.S. equities, while selling off funds that employ sector- and asset allocation-based strategies.
Below, MutualFunds.com takes a closer look at these fund flow dynamics and what they mean for investors moving into the second quarter of a volatile year.
Bonds Bounce Back & Forth
Taxable bonds experienced the greatest outflows in December 2015 following the U.S. interest rate hike; investors moved in to short- and long-government and municipal bonds that offered tax advantages and greater safety. At the time, investors believed that the Federal Reserve would continue to hike interest rates throughout the year as the economy improved, although falling crude oil prices and global volatility began to raise some questions.
The Federal Reserve’s dovish outlook this year has changed sentiments. By February, taxable bonds saw a $12.9 billion influx of capital as investors bet that the central bank would cool off its plans to hike interest rates throughout the year. Intermediate bonds, high-yield bonds, and corporate bonds all reported strong inflows, although investors continue to stick with municipal bonds as a tax-free way to improve their income.
Moving into the second quarter, bond fund flows will depend largely on the central bank’s interest rate decision-making, the state of the U.S. economy, and the performance of the equity markets. The February-April rally in equities could cause a shift back in to equities if the sentiment remains strong, but overall, investors remain cautious with the lofty valuations seen in equities. High-yield bonds may be the preferred choice.
Investors Look Passive & Global
Investors in the equity markets looked primarily to passive and international funds to drive returns. By February, investors were removing just $4.5 billion from equities compared to $14.8 billion in January, which is consistent with the market’s turnaround. The noteworthy point is that these equity flows consisted largely of outflows from active funds and inflows into passive funds, while investors were quick to sell off sector- and allocation-based equity funds.
International equities have seen significant inflows amounting to $4.1 billion by February as investors poured money into foreign large-cap growth and – to a lesser extent – diversified emerging-market funds. With the lower U.S. dollar and high U.S. equity valuations, investors were likely hoping to see these markets outperform with better value opportunities, but these trends could be shifting moving into the latter part of the year.
Looking into the second quarter, emerging-market performance has started to recover as China’s economy has shown signs of improvement. These dynamics could lead to a shift of capital into emerging markets. At the same time, the ongoing slowdown in Japan and other developed markets could lead to a slowdown in global funds focused on those markets, although they may still represent a better value than lofty U.S. equities.
Commodities & Alternatives Gain Steam
Gold prices soared throughout the beginning of the year amid growing economic uncertainty, which drove many investors into gold and alternative investment funds. During the first two months of the year, commodities and precious metals funds saw nearly $7 billion in capital inflows, while managed futures funds reported a $3.7 billion influx of capital.
Whether or not these trends will continue depends largely on the state of the global economy. The improvement in China’s economy could help calm worries of a hard landing, but investors remain concerned about a potential recession in the United States. The International Monetary Fund (IMF) also lowered its global growth forecast in a move that could paint a more bearish picture for equities and overall growth.
The Bottom Line
Fund flows were mixed throughout the first quarter of the year amid a high level of volatility. In the bond market, investors have shifted from a bearish to a bullish stance. In the equity markets, investors remain somewhat bearish with a preference towards international funds. And in commodities, gold prices continue to drive inflows into commodities as a safe-haven asset during the equity market’s volatility.
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