Capital Preservation Trumps Return Maximisation

Asset flows to European funds in Q2 continue to show a thirst for preserving capital rather than maximising returns

Dan Lefkovitz 26 July, 2012 | 10:53AM
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Asset flows to European funds continue to react predictably to the ongoing eurozone crisis and its attendant market turbulence. The liquidity-fuelled market rally of 2012’s first quarter lifted investor confidence and attracted money into funds. Then, with instability in Europe, as well as bad news from the US and China sending markets into fits, European investors withdrew €4.2 billion from long-term funds in the second quarter; June saw €1.2 billion worth of net redemptions from long-term funds.

Money market funds cushioned the blow for the European funds industry in the second quarter.

Roughly €10 billion of investor capital flowed into short-term funds, perhaps reflecting a reallocation from long-term funds.

But a surprising €19 billion left short-term funds in June, the worst month for the asset class since June 2011. More than half of the outflow came from Morningstar’s EUR money market – short term category, with funds offered by JP Morgan and BNP Paribas especially hard hit. Meanwhile, EUR money market also saw €3.6 billion in outflows in June. Meanwhile, a raft of asset managers, including BlackRock, HSBC, and State Street have restricted inflows into their short-term funds in the wake of the ECB lowering rates to protect yields from being diluted by new investor money. 

Equities Remain Out of Favour
Predictably, equity funds were the hardest hit in the second quarter, after having enjoyed net inflows of €3 billion in the first quarter. European investors withdrew more than €21 billion from the broad asset class in the second quarter, with roughly €7.5 billion of those redemptions coming in June. Despite clear jitters, investors in European funds are developing stronger stomachs. The outflows in 2012’s second quarter were not as severe as those witnessed in the second half of 2011 or the dark days of 2008.

At a category level, it wasn’t surprising to see Morningstar’s eurozone large-cap equity peer group leading the board in stock fund outflows, with nearly €2.7 billion exiting in the second quarter and €778 million leaving in June. Nor was it shocking to see the Europe large-cap value equity, Europe large-cap blend equity, France large-cap equity, and Germany large-cap equity categories in net redemptions for the quarter and for June.

More interesting were the €2 billion in outflows from Morningstar’s Asia ex-Japan equity category over the second quarter. The same category had attracted roughly €1.2 billion in the more bullish first quarter of 2012. Morningstar’s China equity category made the same shift from inflows to outflows between the first and second quarters. No doubt, investors fear a Chinese slowdown.

The Bond Boom Continues
Meanwhile, investor appetite for bond funds remains insatiable. Fixed-income funds enjoyed more than €21 billion in inflows in the second quarter, nearly €9 billion of that coming in June. At a Morningstar category level, flows were led by 'other bond,' a miscellaneous grouping. The other bond category contained Europe’s most popular fund for the quarter, Alliance Bernstein American Income Portfolio. That fund attracted strong flows from Asia-based investors who clearly favour its exposure to a perceived safe-haven currency.

Other bond also contains a number of target-maturity bond fund sold by Italian banks to investors eager to shield their euro savings over a defined time frame while receiving a small but steady income stream.

Otherwise, as seen in the below chart, investors continue to search for yield outside the eurozone with their bond funds.

Allocation Funds Balance Fear and Greed
Allocation funds continue to benefit from uncertainty and investor focus on capital preservation over return maximisation. The most popular balanced fund for the second quarter and the year to date was M&G Optimal Income, which carries a Morningstar Analyst Rating of Silver. Carmignac as a house has also benefitted from interest in asset allocation, with three popular allocation funds, including new Carmignac Portfolio Emerging Patrimoine, in the hot emerging allocation category.

Another in-favour fund this year has been Baillie Gifford Diversified Growth; its June inflow of €367 million swelled its asset base beyond €2 billion. 

Meanwhile, Morningstar’s alternatives broad asset class saw more than €3 billion of investor withdrawals in the second quarter, with roughly €1 billion coming in June. The broad asset class includes the guaranteed funds category, which, upon closer examination, is the source of the redemptions. The list of most heavily redeemed funds for the quarter includes many products offered by Spanish banks, so it’s likely that investors fear the banks’ ability to make good on those guarantees.

On the positive side of the alternatives ledger, Standard Life Global Absolute Return Strategies attracted more than €1 billion over the course of the quarter, swelling the asset base of the UK-domiciled fund beyond €14 billion. Meanwhile, the Luxembourg version of the fund, launched in January 2011, has grown to more than €2 billion.

Index Funds and Vanguard Gain Ground
The top-selling equity fund in June was Vanguard FTSE UK All Share Index, with €859 million in inflows. Also among the top 20 equity funds in June were Vanguard FTSE Developed Europe ex UK Equity Index, Vanguard Global Stock Index, and Vanguard Pacific Ex-Japan Stock Index. These passive funds are likely benefitting from the move away from adviser rebates in the UK market and increased focus on controlling fees in a low-return environment.

But as discussed in May’s European asset flows commentary, heavy flows to passive UBS funds show that the trend extends beyond the UK. Index funds still represent just 5.3% of industry assets in Europe (compared with 15% in the US) but passives attracted €1.3 billion in the second quarter, while active funds saw €5 billion in redemptions. Low-cost funds hold added appeal in a low-return world. Research by Morningstar and others shows that low-cost funds tend to outperform.

Vanguard, whose steady climb to largest US asset manager is discussed in Morningstar’s US Asset Flows commentary for June, is also taking market share in Europe. The €2 billion worth of inflows into its European funds for the first half of 2012 made it Europe’s fifth-most-popular fund house this year (excluding money market assets). But with €28 billion in assets in its European fund ranges, it is still a shadow of UBS (€133 billion) and PIMCO (€81 billion).

Read the full report here.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Dan Lefkovitz

Dan Lefkovitz  is strategist for Morningstar’s Indexes group