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8
Ask a mutual fund manager in public or on the record
if inflows or outflows are affecting his ability
to effectively execute his process and the answer
is almost always no. Privately, however, many
fund managers often admit cash flows can be a pain,
particularly at the extremes. A gush of inflows
can force you to hold too much cash or compromise
your security-selection standards to put money
to work; persistent heavy outflows can make a
manager sell holdings he otherwise would hold
and can wear on investment-team morale.
Recently, a seasoned manager and executive of a
top-
20
mutual fund family conceded to Morningstar
analysts that heavy inflows or outflows have a nega-
tive impact on investment strategy implementation
and performance. The optimal scenario is a little
bit of money going out to meet redemptions and a
little more coming in as new investments. Such a
balance of inflows and outflows helps tax efficiency,
he said, and imposes a discipline on managers,
forcing them to regularly think about how to raise or
deploy cash while ensuring the portfolio is optimally
positioned for the strategy.
Putting It to the Test
We tried to gauge the effect of extreme outflows and
inflows on subsequent equity fund performance.
We focused on actively managed equity funds in the
broad large-, mid-, and small-cap domestic asset
classes and in the foreign large- and foreign small/
mid-cap stock fund groups. We divided the funds
into deciles by their net cash flow, or organic growth
rates, at the start of a six-year period from
2006
to
2011
, with the first decile representing the heaviest
outflows or smallest inflows and the
10
th decile
including the funds getting the most inflows. Then
we looked at subsequent three-year absolute per-
formance, Morningstar Ratings, and success ratios,
or the percentage of funds that lived to see the
end of the period and outperformed their respective
Morningstar Category averages.
While not definitive, the results were interesting.
Domestic large-, mid-, and small-cap and foreign
large-cap asset groups saw lower success ratios at
both ends of the spectrum, though more so among
funds getting big outflows. The foreign small-cap
group showed no real pattern.
Among large-, mid-, and small-cap and foreign large-
cap stock funds that were seeing the most outflows,
just
20%
–
26%
of them survived and outperformed
their respective category peers in the subsequent
three-year periods.
Funds in the highest decile—those getting the most
inflows—were more likely than those in the big
outflow groups to survive. That’s not surprising—
what fund company would merge or liquidate a fund
gathering fee-generating assets? However, the
big inflow funds’ subsequent average performance
looked a little worse. Between
36%
and
40%
of
large-, mid-, and small-cap domestic funds in the best
decile for flows managed to survive and outperform
their respective category peers in the subsequent
three-year periods, but their average returns and star
ratings were usually lower than those of the typical
funds in the bottom decile for flows. They also were
lower than the mean of their broad asset classes.
Large-cap funds with the biggest inflows, for example,
averaged
7
.
8%
annualized and earned an average of
2
.
8
stars in the following three-year periods compared
with
8
.
1%
and
3
stars for counterparts that saw
the most outflows; the average large-cap fund with
the most inflows also lagged the
8
.
1%
average large-
cap fund gain over all the periods. Mid-cap asset
attractors gained
9
.
5%
, which was about average for
all mid-cap funds but a percentage point less than
the
10
.
5%
gained by the average mid-cap fund in the
worst decile for outflows. Mid-cap funds with the
highest inflows earned
2
.
8
stars in the following time
periods compared with about
3
for the most-redeemed
mid-cap funds and the asset-class average. The
biggest small-cap flow getters averaged
9
.
5%
and
2
.
8
stars compared with
10%
and
2
.
9
for all mid-cap
How Flows Affect Your Fund
Morningstar Research
|
Daniel Culloton