With nearly $16 trillion in assets, the U.S. mutual fund industry remained the largest in the world at year-end 2015. At the same time, investor demand for mutual funds declined in 2015 with net redemptions from mutual funds amounting to $102 billion, or 0.6 percent of 2014 year-end assets. Investor demand for certain types of mutual funds appeared to be driven in large part by an anticipated tightening in monetary policy, declining oil prices, headwinds from China, and expectations of slower global growth. As a result, though money market funds experienced modest net inflows, long-term mutual funds, particularly those most exposed to interest rate risk, the energy sector, and emerging markets, experienced net outflows for the first time since 2008.

Investor Demand for U.S. Mutual Funds 

A variety of factors influence investor demand for mutual funds, such as funds’ ability to assist investors in achieving their investment objectives. For example, U.S. households rely on equity, bond, and hybrid mutual funds to meet long-term personal financial objectives such as preparing for retirement. U.S. households, as well as businesses and other institutional investors, use money market funds as cash management tools because they provide a high degree of liquidity and competitive short-term yields. Changing demographics and investors’ reactions to U.S. and worldwide economic and financial conditions play important roles in determining how demand for specific types of mutual funds—and for mutual funds in general—evolves.

U.S. Mutual Fund Assets 

The majority of U.S. mutual fund assets at year-end 2015 were in long-term funds, with equity funds alone comprising 52 percent of total U.S. mutual fund assets (Figure 2.1). Bond funds were the second-largest category, with 22 percent of assets. Money market funds (18 percent) and hybrid funds (9 percent) held the remainder.

Figure 2.1

Equity Funds Held More Than Half of Total Mutual Fund Assets

Percentage of total net assets, year-end 2015

Figure 2.1

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Note: Components do not add to 100 percent because of rounding.

Investors in U.S. Mutual Funds 

Demand for mutual funds is, in part, related to the types of investors who hold mutual fund shares. Retail investors (i.e., households) held the vast majority (89 percent) of the nearly $16 trillion in mutual fund assets (Figure 2.2). The proportion of long-term mutual fund assets held by retail investors is even higher (95 percent). Retail investors also held substantial money market fund assets ($1.7 trillion), but that amounted to a relatively small share (12 percent) of their total mutual fund assets.

In contrast, institutional investors such as nonfinancial businesses, financial institutions, and nonprofit organizations held a relatively small portion of mutual fund assets. At year-end 2015, institutions held about 11 percent of mutual fund assets (Figure 2.2). One of the primary reasons institutions use mutual funds is to help manage cash balances. Sixty-two percent of the $1.7 trillion that institutions held in mutual funds was in money market funds.

Figure 2.2

Institutional and Household Ownership of Mutual Funds

Billions of dollars, year-end 2015

Figure 2.2

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1Mutual funds held as investments in individual retirement accounts, defined contribution retirement plans, variable annuities, 529 plans, and Coverdell Education Savings Accounts are counted as household holdings of mutual funds.
2Long-term mutual funds include equity, hybrid, and bond mutual funds.
Note: Components may not add to the totals because of rounding.

Developments in Mutual Fund Flows 

Overall demand for mutual funds as measured by net new cash flow—new fund sales less redemptions plus net exchanges—declined in 2015 (Figure 2.3). Lower demand for equity, hybrid, and bond mutual funds was only partly offset by greater demand for money market funds. Overall, mutual funds had a net cash outflow of $102 billion in 2015, in contrast with a net cash inflow of $104 billion in 2014. In 2015, investors redeemed $123 billion, on net, from long-term funds, and added $21 billion, on net, to money market funds. A number of factors—including a stronger U.S. dollar, falling oil prices, ongoing demographic trends, and increased demand for exchange-traded funds (ETFs)—appeared to influence mutual fund flows in 2015.

Figure 2.3

Net New Cash Flow to Mutual Funds

Billions of dollars, 2000–2015

Figure 2.3

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* In 2012, investors withdrew less than $500 million from money market funds.
Note: Components may not add to the total because of rounding.

The Global Economy and Financial Markets in 2015 

The year 2015 produced an unusual juxtaposition: a growing U.S. economy, but weak or falling profits for many companies in the major stock market indexes. The combination produced lackluster results for investors.

Despite difficulties in certain financial markets, the U.S. economy continued to improve in 2015. U.S. real gross domestic product grew 2.4 percent in 2015, matching the previous year. Unemployment slid from 5.6 percent in December 2014 to 5.0 percent in December 2015, taking the jobless rate to its lowest level since February 2008. Average hourly earnings, which have lagged job growth through most of the recovery, rose 2.6 percent during the year, and total personal income rose 3.9 percent in 2015. Rising wages translated into real buying power as the Consumer Price Index—used as a measure of inflation—rose a mere 0.7 percent for the year, the result mainly of a fall in energy prices. Real retail sales (including food services) rose 1.9 percent for the year and the personal saving rate stayed at 5.0 percent, indicating that consumers used a portion of their income to pay down debt or build assets or both.

Continued progress in jobs and wages prompted the Federal Reserve to increase the federal funds target rate for the first time in nearly a decade. The quarter-point move in short-term rates, which the Fed telegraphed far in advance, had little immediate effect on the market, and the Fed indicated that further increases would be gradual. Remarkably low inflation made that approach easier. The personal consumption expenditures price index rose just 0.7 percent during the year, well below the Fed’s target of 2 percent inflation. Also easing the Fed’s task, the 10-year Treasury bond finished the year yielding 2.27 percent, barely higher than the 2.17 percent yield at the end of 2014. The low yield on long-term bonds indicated market confidence that inflation would remain low.

Developments abroad overshadowed moderate progress in the U.S. economy. The pace of growth slowed in China, where the government reported the economy grew just 6.9 percent in 2015, down from the double-digit gains seen earlier in the 2000s. Concerns heightened that a more tepid Chinese economy would result in weaker Chinese demand for exports from emerging markets across Asia and Latin America. Europe continued its economic recovery, but at a pace considerably slower than in the United States.

The result was a divergence in monetary policy across the globe. Asian and European central banks eased policies, while the Federal Reserve made it clear that tighter policies were ahead. The divergence in monetary policy favored the U.S. dollar. The Wall Street Journal Dollar Index rose 8.6 percent over the year as a whole. This factor, among others, hindered American exports, slowing manufacturing and lowering reported profits of American companies that do business abroad. Reported 12-month earnings per share for the S&P 500 fell to $87 from $102 in 2014.

The slide in oil prices, from $60 per barrel at the end of May to $37 per barrel at year-end, also rattled markets. In the long run, low oil prices are expected to benefit the U.S. economy, improving the trade balance and leaving consumers with more money to spend. But the more immediate effect was to reduce profits for energy companies. Furthermore, weakness in other industrial commodities—from coal to copper—prompted some speculation that Chinese growth might be even weaker than the official statistics indicated.

All of these factors contributed to a mixed year for global stock markets. Pessimism over China and emerging markets prompted a decline of 11 percent in the U.S. stock market during August and September 2015.* Although the stock market bounced back later in the fall, for the year as a whole, the average large-cap blend domestic equity fund lost 1 percent in total return.† Returns on equity funds that invest primarily in a small-cap stocks (e.g., small-cap blend funds) tend to be more variable; for 2015 as a whole, small-cap blend funds returned -5 percent.‡

Meanwhile, concerns over Federal Reserve policy weighed on bond prices at home and abroad. Worries over falling oil prices and reduced profits and potential defaults in the energy sector pushed down high-yield bond prices because energy-related companies had been significant issuers of high-yield debt in the past few years. In addition, a rising dollar made it more difficult for foreign companies to pay down their dollar-denominated debts. On average, high-yield and emerging market bond funds lost 4 and 6 percent in total return in 2015, respectively.§

* As measured by the total return on the S&P 500 index.
† As measured by the Morningstar Large Blend fund category total return.
‡ As measured by the Morningstar Small Blend fund category total return.
§ As measured by the Morningstar High Yield Bond fund category total return and Morningstar Emerging Markets Bond fund category total return.

Long-Term Mutual Fund Flows 

Flows into long-term mutual funds, though correlated with market returns, tend to be moderate as a percentage of assets even during episodes of market turmoil. Several factors may contribute to this phenomenon. One factor is that households (i.e., retail investors) own the vast majority of U.S. long-term mutual fund assets (Figure 2.2). Retail investors generally respond less strongly to market events than do institutional investors. Most notably, households often use mutual funds to save for the long term, such as for college or retirement. Many of these investors make stable contributions through periodic payroll deductions, even during periods of market stress. In addition, many long-term fund shareholders seek the advice of financial advisers, who may provide a steadying influence during market downturns. These factors are amplified by the fact that assets in mutual funds are spread across more than 90 million investors and fund investors have a wide variety of individual characteristics (such as age or appetite for risk) and goals (such as saving for the purchase of a home, for education, or for retirement). They are also bound to have a wide range of views on market conditions and how best to respond to those conditions to meet their individual goals. As a result, even during months when funds as a group see net outflows, some investors continue to purchase fund shares.

Equity Mutual Funds

Flows to equity funds tend to rise and fall with stock prices (Figure 2.4). The MSCI All Country World Daily Gross Total Return Index, a measure of returns on global stock markets, dropped 2 percent in 2015, on the heels of a 5 percent rise in 2014. At the same time, equity mutual funds experienced outflows totaling $77 billion in 2015, compared with $25 billion in inflows in 2014. Flows to equity funds varied throughout 2015 (Figure 2.5). Equity funds received net inflows of $27 billion in the first three months of the year. As the year progressed, flows waned and turned negative. Indeed, equity funds experienced net outflows of $37 billion in December alone.

Figure 2.4

Net New Cash Flow to Equity Funds Is Related to World Equity Returns

Monthly, 2000–2015

Figure 2.4

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1 Net new cash flow is the percentage of previous month-end equity fund assets, plotted as a six-month moving average.
2 The total return on equities is measured as the year-over-year percent change in the MSCI All Country World Daily Gross Total Return Index.
Sources: Investment Company Institute, Morgan Stanley Capital International, and Bloomberg

Figure 2.5

Net New Cash Flow to Long-Term Mutual Funds

Billions of dollars, September 2014–December 2015

Figure 2.5

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* In April 2015, investors added $275 million to hybrid funds; in June 2015, investors added $42 million to hybrid funds.
Note: Components may not add to the total because of rounding.

Outflows from equity funds in the second half of the year likely were related to a combination of greater market volatility and increasing demand for ETFs. The Chicago Board Options Exchange Volatility Index (VIX), which tracks the volatility of the S&P 500 index, is a widely used measure of market risk. Values greater than 30 typically reflect a high degree of investor fear and values less than 20 are associated with a period of market calm. During the first seven months of 2015, the daily VIX averaged 15 and peaked at 22. By comparison, during the volatile months of August and September 2015, the VIX averaged 22 and peaked at 41 in August.

In addition, some portion of assets may have shifted from equity mutual funds into equity ETFs, particularly late in the year. As discussed in chapter 3, the demand for ETFs has been very robust over the past several years. Outflows from domestic equity mutual funds totaled $57 billion in the last three months of 2015, alone accounting for nearly three-quarters of the year’s outflows from equity funds. Over the same three months, net issuance of domestic equity ETF shares totaled $58 billion.

Also, investors in the United States increasingly have diversified their portfolios toward equity mutual funds that invest primarily in foreign markets (world equity funds). Over the past 10 years, domestic equity mutual funds experienced net outflows totaling $834 billion. In the same period, world equity funds received net inflows of $643 billion. In 2015, despite a stronger U.S. dollar, this pattern continued. World equity funds received $94 billion of net new cash while domestic equity funds experienced net outflows of $171 billion.

The strong demand for world equity funds over the past decade reflects a number of factors. One significant factor is that investors have responded to the relative returns realized in domestic versus overseas markets. Between 2003 and 2010, international stocks* performed better than domestic stocks,† returning an average of 13 percent per year compared with 8 percent for domestic stocks. Since 2010, U.S. stocks have significantly outperformed international stocks. Some market commentators, however, have advised investors that lower prices on international stocks relative to earnings could signal that international stocks will outperform U.S. stocks in coming years. And, in 2015, lower profits among U.S. corporations, especially at energy companies and firms with large overseas sales, ended a multiyear run-up in U.S. stock prices. This likely encouraged investors to rebalance portfolios that had become more heavily weighted toward domestic stocks.

* Measured by the MSCI All Country World Daily ex-U.S. Gross Total Return Index.
As measured by the Wilshire 5000 Total Return Index (float-adjusted).

A related factor is that some types of funds, such as target date mutual funds (discussed in more detail here), rebalance portfolios automatically as part of an asset allocation strategy. The assets in funds offering asset allocation strategies have grown considerably over the past decade. These funds typically hold higher weights in foreign equities and bonds than many U.S. investors had traditionally allocated to foreign investments. In addition, as the U.S. domestic equity market rose over the past few years, these kinds of asset allocation funds naturally rebalanced their portfolios away from domestic stocks toward foreign stocks.

Asset-Weighted Turnover Rate

The turnover rate—the percentage of a fund’s holdings that have changed over a year—is a measure of a fund’s trading activity. The rate is the lesser of purchases or sales (excluding those of short-term assets) in a fund’s portfolio divided by average net assets.

To analyze the turnover rate that shareholders actually experience in their funds, it is important to identify those funds in which shareholders tend to concentrate their assets. Neither a simple average nor a median takes into account where fund assets are concentrated. An asset-weighted average gives more weight to funds with large amounts of assets, and accordingly, indicates the average portfolio turnover actually experienced by fund shareholders. In 2015, the asset-weighted annual turnover rate experienced by equity fund investors was 44 percent, well below the average of the past 36 years.

Investors tend to own equity funds with relatively low turnover rates. In 2015, about 52 percent of equity fund assets were in funds with portfolio turnover rates of less than 30 percent. This reflects the propensity for funds with below-average turnover to attract shareholder dollars.

Figure 2.6

Turnover Rate Experienced by Equity Fund Investors


Figure 2.6

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Note: The turnover rate is an asset-weighted average. Data exclude mutual funds available as investment choices in variable annuities.
Sources: Investment Company Institute, Center for Research in Security Prices, and Strategic Insight Simfund

Bond Mutual Funds

Bond fund flows are typically correlated with the performance of bonds (Figure 2.7), which, in turn, is largely driven by the U.S. interest rate environment. A moderate increase in long-term interest rates during the second quarter of the year, coupled with expectations that the Fed would raise short-term interest rates before year-end, contributed to a decline in bond prices. This lowered the total return on bonds for the year.

Figure 2.7

Net New Cash Flow to Bond Funds Is Related to Bond Returns

Monthly, 2000–2015

Figure 2.7

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1Net new cash flow is the percentage of previous month-end bond fund assets, plotted as a three-month moving average. Data exclude flows to high-yield bond funds.
2The total return on bonds is measured as the year-over-year percent change in the Citigroup Broad Investment Grade Bond Index.
Sources: Investment Company Institute, Citigroup, and Bloomberg

Demand for bond funds fell in the second half of 2015 in response to falling performance of bond investments. For example, during the first half of 2015, investment grade bond funds attracted $30 billion in net new cash. In contrast, during the second half of the year, investors redeemed $31 billion. For all bond fund categories, after investing $43 billion in 2014, investors redeemed $25 billion in 2015. Nonetheless, this outflow was relatively small—representing only 0.7 percent of the total assets of bond funds as of year-end 2014.

Outflows from certain categories of bond funds were more notable. Worries over a slowdown in China, the credit quality of energy and commodities-related companies, and the impact of higher future interest rates on bond values contributed to net redemptions from high-yield bond funds totaling $37 billion in 2015, amounting to 9.8 percent of their year-end 2014 assets. Outflows from high-yield bond funds were greatest in December, amounting to $15 billion. Early in that month came an announcement by Third Avenue Management LLC that it had suspended redemptions in one of its mutual funds. This particular fund had experienced outflows for more than a year. To protect the interests of the fund’s investors, the U.S. Securities and Exchange Commission (SEC) issued an order allowing the fund to suspend redemptions and proceed with an orderly liquidation of its remaining assets.

Also in December 2015, world bond funds (which typically hold a mix of bonds denominated in U.S. dollars and foreign currencies) experienced outflows of $13 billion, or 3 percent of assets. These flows were, in part, attributable to the Fed’s quarter-point interest rate hike on December 16. Higher interest rates in the United States put upward pressure on the U.S. dollar, in turn reducing dollar returns on bonds denominated in foreign currencies and making it more expensive for foreign companies to pay off their dollar-denominated debts.

Since the 2007–2009 financial crisis, some observers have expressed concerns that outflows from bond funds could pose challenges for fixed-income markets. There are many reasons to believe such concerns are overstated.

First, though U.S. bond mutual fund assets have risen in the past decade, bond mutual fund assets were only 9.4 percent of the U.S. bond market at year-end 2015, up from 6.7 percent at year-end 2005. This means that about 90 percent of the U.S. bond market is held by investors outside of mutual funds. Furthermore, some of the outflows from bond mutual funds likely reflect growing investor interest in other types of pooled investment vehicles with exposure to bonds. Notably, ETFs that invest in bonds had net issuance of $55 billion in 2015. And, though high-yield bond mutual funds had net redemptions, net issuance of high-yield bond ETFs was $1.8 billion, or 4 percent of the year-end 2014 assets of high-yield bond ETFs.

Second, though some high-yield bond funds at times have had substantial outflows, other high-yield funds have had inflows (Figure 2.8). Thus, outflows at one fund, even substantial outflows that the fund must meet by selling securities, are unlikely to significantly affect bond markets if other high-yield funds are at the same time buying the same or similar securities.

Figure 2.8

Modest Outflows from High-Yield Bond Funds Even During Times of Market Stress

Net new cash flow as a percentage of assets; monthly, February 2000–December 2015

Figure 2.8

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Note: Data exclude high-yield bond funds designated as floating-rate funds. Data also exclude funds with less than $10 million in total net assets, mutual funds that invest primarily in other mutual funds, and data for funds in any fund month where a merger or liquidation takes place. One observation for the top 10th percentile of funds in January 2001 is hidden to preserve the scale.

Third, bond funds have a range of tools they use to meet redemptions. For instance, a long-term fund can often accommodate the vast majority of its redemptions through sales of new fund shares to other investors. At almost any time, some investors will be redeeming out of a given long-term fund while others will be purchasing new fund shares. When redemptions exceed sales of fund shares, bond funds can sell bonds or reduce their holdings of short-term securities. Bond funds, especially high-yield, municipal, and international bond funds, may choose to hold more short-term assets (e.g., Treasury bills) or other highly liquid securities (e.g., common stocks and investment grade bonds) to help meet redemptions. As Figure 2.9 shows, high-yield bond funds as a group held 14.7 percent of their assets in securities that are generally easy to liquidate: 5.3 percent in short-term securities, 2.4 percent in equities, and 7.0 percent in investment grade bonds.

Figure 2.9

High-Yield Bond Fund Holdings by Selected Asset Categories

Percentage of all high-yield bond fund assets, December 2015

Figure 2.9

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* Below investment grade bonds include unrated bonds.
Note: Data include funds Morningstar classifies as high-yield bond funds. Short-term securities are those classified by Morningstar as cash. Data exclude derivatives positions. Components may not add to the total because of rounding.
Source: Morningstar

Funds also use derivatives to help manage flows. Derivatives can be more liquid than their physical counterparts. Regulations require funds to segregate liquid assets to support their derivatives positions. These segregated liquid assets provide a ready source of liquidity to meet redemptions. This is especially true for many so-called liquid alternative funds, which are explicitly designed to allow frequent investor trading and do so in large measure through derivatives.

Finally, funds manage their liquidity according to both fund and investor characteristics. For example, funds with more variable flows tend to hold a greater proportion of their portfolios in liquid assets. When a fund’s adviser expects the fund to have more variable flows, the fund is likely to hold more cash, liquid securities, securities that generate cash (e.g., through coupon payments or prepayments of principal), and highly liquid derivatives.

Despite several periods of market turmoil, bond funds have experienced inflows through most of the past decade. Bond funds have received $2 trillion in net inflows and reinvested dividends since 2005 (Figure 2.10). A number of factors have helped sustain this long-term demand for bond funds.

Figure 2.10

Bond Funds Have Experienced Net Inflows Through Most of the Past Decade

Cumulative flows to bond mutual funds, billions of dollars; monthly, 2005–2015

Figure 2.10

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Note: Bond mutual fund flows include net new cash flow and reinvested dividends. Data exclude mutual funds that invest primarily in other mutual funds.

Demographics influence the demand for bond funds. Older investors tend to have higher account balances because they have had more time to accumulate savings and take advantage of compounding. At the same time, as investors age, they tend to shift toward fixed-income products. Over the past decade, the aging of Baby Boomers has boosted flows to bond funds. Although bond funds experienced outflows in 2015, they were likely mitigated, in part, by the demographic factors boosting bond fund flows over the past decade.

The continued popularity of target date mutual funds also likely helped to limit outflows from bond funds in 2015. Target date mutual funds invest in a changing mix of equities and fixed-income investments. As the fund approaches and passes its target date (which is usually specified in the fund’s name), the fund gradually reallocates assets away from equities toward fixed-income investments, including bonds. Target date mutual funds usually invest through a fund-of-funds approach, meaning they primarily hold and invest in shares of other equity and bond mutual funds. Over the past 10 years, target date mutual funds have garnered inflows of $477 billion. In 2015, target date mutual funds had net inflows of $66 billion and ended the year with assets of $763 billion. The growing investor interest in these funds likely reflects their automatic rebalancing features as well as their inclusion as an investment option in many defined contribution (DC) plans. Also, following the adoption of the Pension Protection Act of 2006, the use of target date funds as default investments for DC plans increased (see chapter 7).

Hybrid Mutual Funds

Hybrid mutual funds have seen inflows every year in the past decade except 2008 and 2015. Hybrid funds, sometimes called asset allocation funds or balanced funds, invest in a mix of stocks and bonds. The fund’s prospectus may specify the asset allocation that the fund seeks to maintain, such as investing approximately 60 percent of the fund’s assets in equities and 40 percent in bonds. This approach offers a way to balance the potential capital appreciation of stocks with the income and relative stability of bonds over the long term. The fund’s portfolio may be periodically rebalanced to bring the fund’s asset allocation more in line with prospectus objectives, which could be necessary following capital gains or losses in the stock or bond markets.

Hybrid funds have become an increasingly popular way to help investors achieve a managed, balanced portfolio of stocks and bonds. Over the past 10 years, investors have added $258 billion in net new cash flow to these funds. In 2015, however, investors redeemed a modest $21 billion (or 1.5 percent of prior year-end assets).

Outflows in 2015 from hybrid funds were concentrated in “flexible portfolio” funds, which have the flexibility to hold any proportion of stocks, bonds, cash, and commodities, both in the United States and overseas. In many ways, the 2008 crisis led investors to broaden their portfolios and lower the correlation of their investments with the market or limit downside risk. Flexible portfolio funds can help investors achieve those goals. As a result, flexible portfolio funds saw net inflows of $88 billion in the six years following 2008. After a long bull market, however, and comparably lower returns in funds offering downside protection, investors redeemed $21 billion (or 6.1 percent of prior year-end assets), on net, from flexible portfolio hybrid funds in 2015.

The Growth of Other Investment Products 

Some of the outflows from long-term mutual funds in 2015 reflect a broader shift, driven by both investors and retirement plan sponsors, toward other pooled investment vehicles. This trend is reflected in the outflows from actively managed funds and the growth of index mutual funds, ETFs, and collective investment trusts (CITs) since 2007.

In 2015, index mutual funds—which hold all (or a representative sample) of the securities on a specified index—remained popular with investors. Of households that owned mutual funds, 32 percent owned at least one equity index mutual fund in 2015. As of year-end 2015, 406 index mutual funds managed total net assets of $2.2 trillion. Demand for index mutual funds remained strong in 2015, with investors adding $166 billion in net new cash flow to these funds (Figure 2.11). Of the new money that flowed to index mutual funds, 28 percent was invested in funds tied to domestic stock indexes, 45 percent went to funds tied to world stock indexes, and another 26 percent was invested in funds tied to bond or hybrid indexes.

Index equity mutual funds accounted for the bulk of index mutual fund assets at year-end 2015. Eighty-one percent of index mutual fund assets were invested in funds that track the S&P 500 or other domestic or international stock indexes (Figure 2.12). Mutual funds indexed to the S&P 500 managed 31 percent of all assets invested in index mutual funds. The share of assets invested in index equity mutual funds relative to all equity mutual funds’ assets moved up to 22 percent in 2015 (Figure 2.13).

Figure 2.11

Net New Cash Flow to Index Mutual Funds

Billions of dollars, 2000–2015

Figure 2.11

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Note: Components may not add to the total because of rounding.

Figure 2.12

Funds Indexed to the S&P 500 Held 31 Percent of Index Mutual Fund Assets

Percentage of total net assets, year-end 2015

Figure 2.12

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Figure 2.13

Index Equity Mutual Funds’ Share Continued to Rise

Percentage of equity mutual funds’ total net assets, 2000–2015

Figure 2.13

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Index domestic equity mutual funds and index-based ETFs have particularly benefited from the investor trend toward more index-oriented investment products. From 2007 through 2015, index domestic equity mutual funds and ETFs received $1.2 trillion in net new cash and reinvested dividends (Figure 2.14). Index-based domestic equity ETFs have grown particularly quickly—attracting almost twice the flows of index domestic equity mutual funds since 2007. In contrast, actively managed domestic equity mutual funds experienced a net outflow of $835 billion (despite including reinvested dividends) from 2007 to 2015.

CITs are an alternative to mutual funds for DC plans. Like mutual funds, CITs pool the assets of investors and (either actively or passively) invest those assets according to a particular strategy. Much like institutional share classes of mutual funds, CITs generally require substantial minimum investment thresholds. Unlike mutual funds, which are regulated under the Investment Company Act of 1940, CITs are regulated under banking laws, which can reduce their compliance costs as compared to mutual funds.

More retirement plan sponsors have begun offering CITs as options in 401(k) plan lineups. As Figure 2.15 demonstrates, this trend has translated into a growing share of assets held in CITs by 401(k) plans with 100 participants or more. That share increased from 6 percent in 2000 to an estimated 16 percent in 2014. This most recent expansion is owed, in part, to growth in target date fund CITs.

Figure 2.14

Some of the Outflows from Domestic Equity Mutual Funds Have Gone to ETFs

Cumulative flows to and net share issuance of domestic equity mutual funds and index ETFs, billions of dollars; monthly,
January 2007–December 2015

Figure 2.14

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Note: Equity mutual fund flows include net new cash flow and reinvested dividends. Data exclude mutual funds that invest primarily in other mutual funds.

Figure 2.15

Assets of Large 401(k) Plans Are Increasingly Held in Collective Investment Trusts

Percentage of assets in 401(k) plans with 100 participants or more, 2000–2014

Figure 2.15

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Note: Assets exclude Direct Filing Entity (DFE) assets that are reinvested in collective investment trusts. Data prior to 2014 come from the Department of Labor Form 5500 Research Files. Data for 2014 are preliminary, based on Department of Labor 2014 Form 5500 Latest Data Sets.
Source: Investment Company Institute tabulations of Department of Labor Form 5500 data

Demand for Money Market Funds 

In 2015, money market funds received a modest $21 billion in net inflows. Like demand for long-term funds, however, demand for money market funds fluctuated in 2015. In particular, money market funds experienced outflows in the first four months of 2015, with investors redeeming $162 billion, on net (Figure 2.16). Tax payments by corporations in mid-March and individuals in mid-April were likely key drivers behind these redemptions. Outflows abated and money market funds received net inflows of $183 billion over the last eight months of the year. About half of these flows went to government money market funds.

Figure 2.16

Net New Cash Flow to Money Market Funds

Billions of dollars, September 2014–December 2015

Figure 2.16

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* In February 2015, investors withdrew $429 million from tax-exempt money market funds.
Note: Components may not add to the total because of rounding.

Institutions rely more heavily on money market mutual funds to manage their cash today than they did in the early 1990s. For example, in 2008, U.S. nonfinancial businesses held 37 percent of their cash balances in money market funds, up from just 6 percent in 1990 (Figure 2.17). Though this portion has declined since the 2007–2009 financial crisis, it remains substantial, measuring 23 percent in 2015. Part of this demand reflects the outsourcing of institutions’ cash management activities to asset managers. Depending on the amount of cash an institutional client wishes to invest and how the client wants the assets managed, it may invest in a money market fund or, alternatively, in a separate account—an account wholly owned by the institutional investor and managed on its behalf by an asset manager. Institutional money market funds—used by businesses, pension funds, state and local governments, and other large-account investors—had net inflows of $16 billion in 2015, following a net inflow of $37 billion in 2014 (Figure 2.18).

Figure 2.17

Money Market Funds Managed 23 Percent of U.S. Businesses’ Short-Term Assets in 2015

Percent; year-end, selected years

Figure 2.17

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Note: U.S. nonfinancial businesses’ short-term assets consist of foreign deposits, checkable deposits, time and savings deposits, money market funds, repurchase agreements, and commercial paper.
Sources: Investment Company Institute and Federal Reserve Board

Individual investors tend to withdraw cash from money market funds when the difference between yields on money market funds and interest rates on bank deposits narrows or becomes negative. Because of Federal Reserve monetary policy, short-term interest rates remained near zero through most of 2015. Yields on money market funds, which track short-term open market instruments such as Treasury bills, also hovered near zero and remained below yields on money market deposit accounts offered by banks (Figure 2.19). Retail money market funds, which principally are sold to individual investors, saw a small net inflow of $5 billion in 2015, following a net outflow of $31 billion in 2014 (Figure 2.18).

Figure 2.18

Net New Cash Flow to Retail and Institutional Money Market Funds

Billions of dollars, 2000–2015

Figure 2.18

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* In 2012, investors added $1 billion to institutional money market funds and withdrew $1 billion from retail money market funds. On net, investors withdrew less than $500 million from money market funds.
Note: Components may not add to the total because of rounding.

Figure 2.19

Net New Cash Flow to Taxable Retail Money Market Funds Is Related to Interest Rate Spread

Monthly, 2000–2015

Figure 2.19

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1 Net new cash flow is the percentage of previous month-end taxable retail money market fund assets, plotted as a six-month moving average.
2 The interest rate spread is the difference between the taxable retail money market fund yield and the average interest rate on money market deposit accounts.
Sources: Investment Company Institute, iMoneyNet, and Bank Rate Monitor

Recent Reforms to Money Market Funds 

The SEC has amended Rule 2a-7, a regulation governing money market funds, several times since 1983, placing greater limits on the maturity and credit quality of the securities that these funds are allowed to hold, adding diversification requirements, requiring minimum levels of liquidity for the funds, and expanding required disclosure. In response to the 2007–2009 financial crisis, the SEC significantly reformed Rule 2a-7 in 2010. Among other things, these reforms required money market funds to hold a certain amount of liquidity and imposed stricter maturity limits.

One outcome of these provisions is that prime funds have become more like government money market funds. To a significant degree, prime funds adjusted to the SEC’s 2010 amendments to Rule 2a-7 by adding to their holdings of Treasury and agency securities. They also boosted their assets in repurchase agreements (repos). A repo can be thought of as a short-term collateralized loan, such as to a bank or other financial intermediary. Repos are collateralized—typically by Treasury and agency securities—to ensure that the loan is repaid. Prime fund holdings of Treasury and agency securities and repos have risen substantially as a share of portfolios, from 12 percent in spring 2007 to a peak of 36 percent in fall 2012 (Figure 2.20). In December 2015, this share was 34 percent of prime fund assets, still more than double the value before the financial crisis and subsequent reforms.

Figure 2.20

Prime Money Market Fund Holdings of Treasury and Agency Securities and Repurchase Agreements

Percentage of prime funds’ total net assets; month-end, 2000–2015

Figure 2.20

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In July 2014, the SEC adopted additional rules for money market funds, precluding the use of amortized cost accounting by institutional funds that invest more than one-half of 1 percent of their assets in nongovernment securities, and by requiring that such funds price their shares to the nearest one-hundredth of a cent (i.e., float their NAVs [net asset values]). Additionally, under the July 2014 rules, nongovernment money market fund boards can impose liquidity fees and gates (temporary halt redemptions) when a fund’s weekly liquid assets fall below 30 percent of its total net assets (the regulatory minimum). The July 2014 rules also include additional diversification, disclosure, and stress testing requirements, as well as updated reporting by money market funds.

Because the new rules will not be fully implemented until late 2016, it is not yet clear how the reforms will affect investor demand for money market funds. In late 2015, however, some money market fund sponsors altered their product offerings on the view that demand for prime money market funds, both from institutional and retail investors, will decline once the July 2014 rules are fully implemented. In late 2015, a total of $188 billion in assets migrated from prime funds into government funds through mergers with existing funds or through changes in funds’ investment strategies. As a result of these and other factors, the total net assets of institutional and retail classes of prime money market funds fell by $77 billion and $103 billion, respectively, during the last two months of 2015. As expected, these reductions were offset by growth in the assets of government money market funds (Figure 2.21). By the end of 2015, assets in prime funds were at their lowest level since 2004 and assets in government funds were at their highest level since 2008.

Figure 2.21

Assets Migrated from Prime Funds into Government Funds in 2015

Billions of dollars; monthly, 2015

Figure 2.21

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The Federal Reserve’s Overnight Reverse Repo Facility

In 2013, anticipating the need to begin absorbing excess liquidity from the financial system, the Federal Reserve introduced a program of fixed-rate, full-allotment, overnight, and term reverse repos. The introduction and expansion of the Fed’s reverse repo facilities over the past three years has greatly increased the central bank’s role as a repo counterparty.

Through these facilities, money market funds (and other market participants) engage with the Fed in overnight or term repos. At the end of 2015, the Federal Reserve was the repo counterparty for 54 percent of the $718 billion in repurchase agreements entered into by taxable money market funds. This share has risen from 29 percent at the end of 2013, the year the program began.

The rise, however, reflects a strong seasonal pattern. Money market fund repurchase agreements with the Fed tend to spike at quarter-ends, in large part because of changes in bank regulations, especially in Europe. Historically, European banks have been major repo counterparties with money market funds. Due to regulatory changes, however, European banks have generally become less willing to borrow from U.S. money market funds, especially at the end of the quarter. In such instances, money market funds, seeking to remain fully invested at quarter-ends, have engaged in repurchase agreements with the Fed. This explains the seesaw pattern that emerges in 2014 and 2015 (Figure 2.20).

2014 Fund Reclassification

To reflect changes in the marketplace, ICI modernized its investment objective (IOB) classifications for open-end mutual funds in 2014.

ICI reports data on open-end mutual funds at several levels. At the macro level, the ICI data categories—domestic equity, world equity, taxable bond, municipal bond, hybrid, taxable money market, and tax-exempt money market funds—have remained the same.

The update reclassified the categories at a more detailed level. This means that there is a break in the time series for some of the data in Fact Book.

Learn More

  • 2014 Mutual Fund Reclassification FAQs
  • Mutual Fund Investment Objective Definitions

Available at www.ici.org/iob_update.

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