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Stocks Making Up for Lost Ground

Most equity categories have recorded year-to-date inflows amid tempered investor interest in bonds, and several active fund shops are benefiting.

Christine Benz: Hi, I'm Christine Benz for After shunning stock funds for most of the past several years, investors have once again been buying them. Joining me to discuss what types of funds they've been buying is Shannon Zimmerman. He's associate director of fund analysis for Morningstar.

Shannon, thank you so much for being here.

Shannon Zimmerman: Good to be with you, Christine.

Benz: Shannon, we had seen this great series of inflows into bond funds really as equities went up and up and up. So far in 2013, we've seen a little bit of a reversal of that or a lot of a reversal, where investors have once again been buying equity funds.

Let's talk about what has been driving these flows.

Zimmerman: Sure. During the last three months, if you look at all of our bond categories, there's only one that has made any money at all. It's barely positive, and that's the bank-loan category. All the rest have declined over the last three months, and it feels a bit like the chickens are coming home to roost. Market watchers for a long time have been expecting the tide to turn because yields have been historically low for so long. There was really only up for them to go, and that seems to be what is happening. You never know if it's correlation, or if there's another dynamic that could be involved. But at the same time, that's been going on, investors have indeed been transitioning out of the fixed-income peer groups and into the equity categories.

Benz: And of course, we've also had really quite strong equity market performance.

Zimmerman: We have, and so maybe some performance-chasing is happening along the way, too.

Benz: When you look at fund flows, what you've seen is that we've seen very strong flows into exchange-traded funds and indexed products, but not so much actively managed funds.

Zimmerman: That's right. If you look at the flows into equity funds on a year-to-date basis, the vast majority of flows have been to Vanguard and have been into passive vehicles. But actively managed funds have not been completely left behind.

Benz: When you look at where the flows have been going on a category-by-category basis, which of the groups have been seeing the biggest inflows?

Zimmerman: Large blend by far. If you look at the assets that have come into both active and passively managed products [the large-blend category] is by far the biggest asset gatherer so far in the year, but most of the categories, all but two, as a matter fact--mid-cap growth and large growth--have enjoyed inflows. Among those that have enjoyed inflows, small value is the worst, but in absolute terms, it has done quite well with about $2.5 billion in inflows.


Benz: Shannon, I know, you specialize in actively managed funds. When you look at the subset of actively managed funds that have been actually seeing new investor dollars flow in, what are some of the shops and specific funds that have been seeing new investor monies come in the door?

Zimmerman: It's interesting and encouraging in a way. There are a couple of shops I regard as boutiques, sort of smaller players. Managers Funds and Brown Advisory are among the biggest asset gatherers on a year-to-date basis. Managers has an all-star lineup kind of approach.

Benz: A multimanager type of thing.

Zimmerman: Yes, they are a manager of managers, trying to put together complementary strategies in a single vehicle. And Brown Advisory is a small, very strong shop. If you look at the top 10 firms by asset flows on a year-to-date basis, they've been among the winners, and so has John Hancock, which is one of biggest fund shops by assets anyway.

Benz: Let's dig into that John Hancock fund, Shannon. What do investors appear to be liking about that particular product?

Zimmerman: Well, it has a successful long-term track record with a long-tenured management team. It's a large-value fund, JHancock3 Disciplined Value, and it has been disciplined over the course of a long time. So the process is repeatable, and as I said, the management team has been in place for a while. They are responsible for an impressive track record. It's not as inexpensive as I would like it to be. I cover the fund, and it's a Bronze-rated fund for Morningstar fund analysts, primarily because of the expense ratio. But it's a strong fund in a category that after large blend has done quite well in terms of the asset gathering so far on the year, large value.

Benz: [It has a] good manager and good team, but you'd like to see the price tag a little lower.

Zimmerman: Exactly.

Benz: Another find out within the Fidelity lineup has been seeing really good fund flows, that's Fidelity Leveraged Company Stock. We've talked about this fund before. It's a volatile fund.

Zimmerman: Yes, it is.

Benz: But has had quite good recent performance. Let's talk about what that fund is and why investors appear to be buying?

Zimmerman: It's a very interesting fund, and [its methodology] is baked into the name, Fidelity Leveraged Company Stock. In 2008, it behaved in exactly the way you would think a leveraged fund would. As credit markets seized up, it collapsed.

Benz: It's not literally leveraged itself. It focuses on companies that have leverage on their balance sheets?

Zimmerman: Exactly, right. So the manager, Tom Soviero, actually comes from Fidelity's high-yield group. He only manages equity money now, but for years he was a manager on the high-yield side and was the director of that team, as well. But now he's just running equity money and convertible bonds; he has a convertible-bond fund, as well. And to your point, that's exactly right. The fund itself is not leveraged, but he invests in companies whose debt/capital ratio, which is an indicator of how indebted the company is, are higher, well-above-average relative to his benchmark.

Benz: More broadly, Shannon, are you concerned, when you look at some of these hot selling funds, that there is some performance-chasing going on here?

Zimmerman: I am, but then when you consider how long, particularly on the active side, that part of the industry was wandering in the wilderness, it seems like there is some ground to make up, at least on a relative basis. Fixed income was continuing to see torrential inflows well past the point where a lot of people thought it was wise for investors to be entering that asset class.

I think the folks have the sense that the risk characteristics of asset classes are etched in stone, and really they're not. It's a moving target. When yields are at historic lows, there is only up for those to go, which means that the prices are going to fall. And investors in either fixed income or equities, all need to be focused on total return because if price erosion takes back what the yield gives, then you really haven't earned anything.

Benz: Shannon, thank you so much for being here to share you insights.

Zimmerman: My pleasure.

Benz: Thanks for watching. I'm Christine Benz or

Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.