Quest for Income: Q1 Fund Flows Favour Alternative Sources

Fund flows in
the global
mutual fund
industry have
been telling an
interesting
story
regarding
changing
investor
appetites.
Here, Gabriel
Altbach,
Pioneers Head
of Global
Strategy and
Marketing,
shares his
perspectives
on recent
trends in the industry and what it might mean for investors and money
managers during the balance of 2016.
It has been a challenging start to the year for the global mutual funds industry,
buffeted as it was by tough market conditions and increasing risk aversion among
investors. After almost uninterrupted growth between 2011 and 2015, global mutual
fund industry showed some weakness in the first quarter of 2016, with assets under
management (AUM) down 3.2% compared to year-end 2015[1]. Investors concerns
regarding a Chinese hard landing, slowing global economic growth and the risks of
unforeseen consequences of extraordinary central bank policies drove the sell-off in
financial markets, particularly in January and February. With those market
conditions as backdrop, mutual fund asset values showed declines, particularly for
funds more exposed to equity markets as well as more equity-sensitive credit
instruments. At the same time, investors reacted by shifting assets away from those
funds more exposed to market volatility, to, on the one hand, asset classes they
perceived to be safer (i.e. higher-quality bonds), and on the other hand, funds
targeting low correlations with traditional asset classes, such as liquid alternatives. In
terms of fixed income, USD bond funds were among those with the strongest inflows,
as US domiciled investors turned back to the category, as expectations for an
imminent further tightening by the FED declined. Alternative solutions, remained

very popular as during 2015[2], being regarded by investors as an alternative way

to further diversify portfolio risk. Liquid alternative and absolute return funds were
favoured especially by European investors, with absolute return multi-asset and
alternative multi-strategy getting the largest chunk of the inflows. Some interest was
expressed for funds using long/short and market neutral strategies as well.
Global mutual fund industry net flows in 1Q16

Source: Strategic Insight Simfund database, as of May 9, 2016.

Active equity and multi-asset funds, were among the hardest-hit by market
turbulence, with overall outflows of around 100bn globally. US equity funds and
multi-asset flexible solutions were the two specific categories bleeding the most
assets, with the most negative sales coming from US investors for the former, and
from Chinese investors as regards the latter. Interestingly, there was a notable bright
spot in Global equities, which ended the quarter with some positive net flows, most
of which came from the US.
The negative sentiment on the part of investors was particularly strong in January,
with mutual funds suffering net redemptions for 117bn. In the following 2 months,
however, the stabilization of financial markets, on the back of prompt interventions
by Central Banks, combined with more reassuring global economic data, helped the
industry regain ground, ending the quarter with outflows of just 11bn, 0.04% of
total assets.
We believe that some of the characteristics of Q1s flows will likely
continue for most of the year, with investors on the sidelines looking for

alternative sources of income with a balance of risk/reward. We are living

in an unprecedented period of low growth and low inflation with the consequence
that expected returns for most asset classes will be lower than in the past. At the
same time, multiple sources of volatility will likely continue to affect investor
sentiment, such as the prospective Brexit referendum, tense electoral seasons in
Europe and in US, the uncertain timing of Central Banks exit strategy and overall
economic conditions that remain fragile.
As the outlook for the economy and financial market continues to be extremely
uncertain, we believe that investors will continue to search for alternative source of
diversification of their portfolios, to try to limit the downside during phases of
market turmoil, while pursuing additional returns. Therefore, we believe the positive
trend we have seen in favour of liquid alternatives in Q1 would continue in coming
quarters.
In addition, the search of income will continue to be a key ongoing dynamic, as
traditional income sources primarily government bonds are not able to provide
adequate income (almost 80% of government bonds in Europe trade at yields below
1%[3]). This quest for income will likely require investors to broader their fixed
income exposures, prompting many to move into the multi-asset space.
The multi-asset setback in Q1, was in our view, the result of a tactical move to
reposition portfolios during a period of acute turmoil, rather than a strategic reversal
of the trend that saw these funds draw great demand by investors in 2015. We note
that most of the outflows in 1Q16 were recorded in China, hit by strong redemptions
after the record sales of 2015. In Europe, on the other hand, multi-asset products
ended the quarter with just slightly negative flows, with investors remaining in a
wait-and-see attitude. We believe that a new generation of multi-asset products,
focus on diversifying among various components, combined with enhanced
techniques of risk management seeking to limit portfolio drawdown will be back
among investors preference in the remaining part of the year.
A few final words on equities. In Q1 the industry saw continued demand for passive
products. This trend will likely continue, with passive solutions growing at the
expense of active solutions especially those that are unconvincingly differentiated
from their benchmarks. However, with less directional market trends ahead, truly
active managers that are able to seek out additional returns through downside
protection and a high conviction approach could well be back in favour by investors.
[1] The data include all mutual funds, active and passive (including ETF), but exclude
FoFs, in order to avoid duplications of assets and flows. Source Strategic Insight
Simfund database.
[2] Source: Strategic Insight Simfund database. In 2015 alternative solutions
(including absolute return funds) gathered inflows for over 100bn globally.
[3] Source: Bloomberg, data as of April 30, 2016.