What factors drive mutual fund flows?

Lee Davidson, CFA, head of quantitative research for Morningstar, and his colleagues have conducted research that looks at the types of fund characteristics that investors seem to prefer. Using historical investor preferences for mutual funds as expressed in monthly fund flow data, Davidson looked at 13 years of data on more than 75,000 funds globally.

During a Morningstar Investment Conference session on Monday in Chicago, Davidson revealed some of the more surprising factors within the fund flows.

Here are four of those factors:

1. Lower fees matter more in the U.S. than globally.

“Holding all else equal, if you’re looking at two cars and everything is the same about them but one costs a lot less, you probably should buy the one that’s cheaper,” Davidson explained. “That’s what this is saying here. European and Canadian investors just haven’t really been doing that. It could be the way that funds are distributed. But that’s a peculiar finding.”

There is a “massive aversion” to high-cost funds in the U.S., according to Davidson. Davidson found this to be true of both equities and fixed income. He added that this aversion doesn’t seem to show up elsewhere, except in Asia.

“This is something I haven’t heard very many people talk about,” he said.

2. Socially responsible investing not necessarily popular in Europe.

“We generally think of [socially responsibly investing] as being a European thing, or I’ve heard a lot of people say that,” Davidson said. “We definitely see it in the U.S. … but in funds that are domiciled locally in Europe and sold to local investors, we actually don’t see as strong of an appreciation for funds that invest responsibly socially or environmentally.”

Davidson said that in Asia his research found that investors were not big fans of socially responsible investing either.

“I don’t have a great explanation for why that is, but these correlations … are pretty indisputable,” he added.

3. The investor preference for value exposure over time has subsided considerably.

Since 2008, investors have not rewarded value funds with additional assets, according to Davidson.

“Value funds … were seeing 1% growth per month more than funds that were more growth oriented from 2003 to January 2007,” he explained. “And then all of a sudden it fell off a cliff right as we were starting to enter into the time before the recession; it’s never recovered since then.”

Davidson explained that the data doesn’t show exactly why these flows changed.

“It’s hard to see where they went and where they left. We can just see differences in growth rates,” he said. “It could be at this point in time they all went into a different asset class and growth funds didn’t have that same affect,” he said.  

4. Investors value greater continuity of management.

“This is my favorite result because it’s another thing I wasn’t expecting,” Davidson said. “I would have thought that managers who were long tenured probably were long-tenured because they were pretty good and they probablygot flows because they were pretty good [managers].”

However, after Davidson and his team controlled for how good a manager’s track record was, they still saw a preference among investors for long-tenured managers.

“On the basis of just the length of time this manager has been around we see a correlation historically of more organic growth per month,” he said. The research also showed that the loss of a long-tenured manager has significantly negative consequences for flows into the fund.

“Let’s say that manager retires and you promote an analyst who’s been on that fund for a long time; we see a massive dropoff in the [fund's asset] growth rate.”

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