A close look at the 489 mutual funds that opened for business last year reveals the reversal of a long-term post-crisis trend.
The percentage of new fund offerings made up of alternative strategy funds fell over six points to 15.8%, while equity funds saw their allocation grow almost nine points to 45.4%. This shift may have been in response to the growing confidence in equity markets prior to 2015. Understanding these shifts may help advisors and their clients on deciding when to use alternatives.
In the years following the 2008 global financial crisis, alternative strategy funds accounted for over 17.3% of all new mutual fund offerings, peaking at 22.1% in 2014. In the five years preceding the crisis, they accounted for just 5.5% of new offerings.
After suffering over $430 billion of net outflows in the years directly following the crisis, equity funds were flooded with $271 billion of net new money in 2013 and 2014.
Equity markets also experienced a robust recovery after hitting crisis lows. The S&P 500 appreciated for five of the first six years after the crisis, for a total return of just below 128%. With these positive indicators, product development managers at fund companies apparently thought it was time to start emphasizing equity funds again.
However, the results of 2015 may have put an end to that trend. Investors pulled money out of equity funds to the tune of $67.8 billion last year, and the S&P 500 suffered its first yearly loss (-0.7%) since 2011 (-0.003%).
The new year started as 2015 ended, with losses in equity markets and investors fleeing from mutual funds. The S&P 500 lost 5.1% in January. Things don’t look any better on the fund flows side, as investors have continued their exodus out of equity funds (-$11.9 billion in net outflows).
So where does that leave product development managers at mutual fund companies? Will they pivot back to the post-crisis trend of launching a higher percentage of alternative strategy funds, or will they continue to increase the number of equity funds they develop?
A major input into this decision will be their forecast for the broad equity market. If it is predicted that the slump is only temporary, then equity funds will most likely continue to curry favor among product-development managers. But if the S&P 500 continues to retreat further into correction territory or worse, it is more probable that a higher number of alternative strategy funds will surface.
The increase in alternative strategy options post-crisis made perfect sense, as this type of fund is intended to be used as a means of hedging or mitigating market risk, which may be a prime concern of clients during a volatile time for equities. These funds implement a hedge fund-like strategy, often incorporating one or a combination of the following: leverage, derivatives, short positions and/or multiple asset classes. Thomson Reuters Lipper parses alternative strategy funds into 10 separate classifications.
THE LONG AND SHORT OF IT
Two of these categories – long/short equity funds and absolute return funds – distinguished themselves during the post-2008 period for having the most new launches. As the name spells out, long/short equity funds combine long positions in stocks that are anticipated to increase in price, and short positions in those expected to depreciate. This type of strategy reduces market risk because the shorts offset the long market exposure. Over 100 new long/short equity funds were launched post-crash, compared to just six new products of this type in the five years leading up to the crisis.
Absolute return funds, on the other hand, aim for positive returns in all market conditions. This type of fund is not benchmarked against a traditional long-only market index; instead, it typically has the aim of outperforming a cash or risk-free benchmark.
Not being tied to a specific benchmark gives absolute return funds the ability to allocate assets to a wide range of investments and use multiple strategies for hedging risk. Similar to long/short equity funds, absolute return funds saw their initial public offerings jump: from five funds in the years leading up to the crash to 82 funds afterwards.
Meanwhile, equity funds saw their allocation among new mutual fund offerings shrink after 2008. Equity funds accounted for almost 49% of all new funds launched in the time period prior to 2008, but saw that allocation shrink to 41% in the post-crash years, with a low point of 37% in 2014.
Within the post-crash equity fund universe, fund management companies have looked for new growth stories. The one group of funds that stood out above the rest was emerging markets funds. Almost 150 new emerging markets funds sprang up after 2008, an increase of almost 125 funds from the pre-cash time period. At the same time, the industry ratcheted down its commitment to U.S. diversified equity funds. USDE funds accounted for 29.5% of all new funds launched pre-crash, but only 16.4% post-crash.
Unfortunately, from the current data, it looks like product development managers are still trying to determine which way the wind will blow this year. Year to date, only 21 new mutual funds have launched, of which four are equity funds and two are alternative strategy products.
Overall, things are off to a slow start this year; at this pace, the industry will introduce only around 250 new mutual funds in 2016, its lowest number since 2009. Of all fund categories, mixed-asset funds make up the largest number of new products launched in 2016, with 10 so far; all 10 are target date investment funds from Virtus Investment Partners.
Interestingly, despite accounting for just 23% of new funds launched in 2015, mixed-asset funds attracted over $51.2 billion of net inflows, representing 51.6% of net inflows to all new funds. A suite of target date retirement funds launched by the Vanguard Group accounted for almost all net inflows (+$48.7 billion) for this fund group.
Perhaps Vanguard and Virtus have identified the new trend for advisors and clients to navigate what may be choppy investing waters in the year ahead.
Patrick Keon is a research analyst specializing in U.S. fund classifications and portfolio analytics at Lipper.