Investor Demand for US 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, US households rely on equity, bond, and hybrid mutual funds to meet long-term personal financial objectives such as preparing for retirement. US 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 US 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.

US Mutual Fund Assets

The majority of US mutual fund assets at year-end 2016 were in long-term funds, with equity funds alone comprising 52 percent of total US mutual fund assets (Figure 2.1). Bond funds were the second-largest category, with 22 percent of assets. Money market funds (17 percent) and hybrid funds (8 percent) held the remainder.

Figure 2.1

Equity Mutual Funds Held About Half of Total Mutual Fund Assets

Percentage of total net assets, year-end 2016

Figure 2.1

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

Entry and Exit of US Mutual Funds

Mutual fund sponsors create new funds to meet investor demand, and they merge or liquidate those that do not attract sufficient investor interest. A total of 439 mutual funds opened in 2016 (Figure 2.2). Fewer world equity and taxable bond fund launches contributed to the decline in the number of new mutual funds offered from 2015 to 2016. In addition, the number of mutual fund liquidations increased substantially—from 290 in 2015 to 426 in 2016, pushing up the total number of funds that exited the industry to 602. Of the funds that were liquidated in 2016, about 30 percent were domestic equity mutual funds.

Figure 2.2

Number of Mutual Funds Entering and Exiting the Industry

2007–2016

Figure 2.2

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Note: Data include mutual funds that do not report statistical information to the Investment Company Institute and mutual funds that invest primarily in other mutual funds.

Investors in US 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 $16.3 trillion in US mutual fund assets (Figure 2.3). 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 amounts to a relatively small share (11 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 2016, institutions held about 11 percent of mutual fund assets. One of the primary reasons institutions use mutual funds is to help manage cash balances. Sixty-one percent of the $1.7 trillion that institutions held in mutual funds was in money market funds.

Figure 2.3

Households Held the Majority (89 Percent) of Mutual Fund Assets

Trillions of dollars, year-end 2016

Figure 2.3

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1 Mutual 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.
2 Long-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 further in 2016 (Figure 2.4). Lower demand for equity, hybrid, and money market funds was only partly offset by greater demand for bond funds. Overall, mutual funds had a net cash outflow of $229 billion in 2016, following a net cash outflow of $101 billion in 2015. In 2016, investors redeemed $199 billion, on net, from long-term funds, and $30 billion, on net, from money market funds. A number of factors—including regulatory reform of money market funds, ongoing demographic trends, and increased demand for indexed products—appeared to influence mutual fund flows in 2016.

Figure 2.4

Net New Cash Flow to Mutual Funds

Billions of dollars; annual, 2007–2016

Figure 2.4

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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 2016

Economic activity hit a soft patch in the United States in 2016 with real gross domestic product (GDP) expanding at a tepid 1.6 percent rate, down from 2.6 percent in 2015. A couple of major items contributed to the slowdown in GDP growth. For 2016 as a whole, capital spending declined for the first time since 2009, as businesses were reluctant to replace or upgrade plants and equipment. In addition, businesses kept their inventory levels in check, which produced a drag on GDP growth in 2016.

Despite weaker overall economic activity, other aspects of the US economy continued to improve in 2016. The labor market strengthened further with the unemployment rate dropping from 5.0 percent at year-end 2015 to 4.7 percent at year-end 2016. In addition, average hourly earnings, which had lagged job growth through most of the recovery from the 2007–2009 financial crisis, rose 2.9 percent in 2016, up from a 2.5 percent increase in 2015. Strong gains in domestic stock prices and house prices fueled a 6.3 percent increase in US household wealth in 2016. The S&P 500 index returned 12.0 percent and the S&P Corelogic Case-Shiller US National Home Price Index rose 5.7 percent. The December 2016 level of the home price index indicated that house prices had fully recovered relative to their previous peak in 2006.

Weaker than expected economic growth in 2016 prompted the Federal Reserve to delay any further increases in the federal funds rate until the end of the year. This tightening in monetary policy was widely expected, so the quarter-point move in short-term rates in December 2016 had little impact on the markets. The decision to raise the federal funds rate was made easier by a moderate increase in inflation. The Consumer Price Index rose 2.1 percent over the year, closer to the Fed’s target of 2 percent inflation and up from 0.7 percent in 2015. Also easing the Fed’s task, the yield on the 10-year Treasury bond rose 96 basis points* over the second half of 2016, with more than half of that increase coming after the US presidential election. The higher yield on long-term bonds likely reflected market participants’ expectations of more expansionary fiscal policies.

* Basis points simplify percentages written in decimal form. A basis point equals one-hundredth of 1 percent (0.01 percent), so 100 basis points equals 1 percentage point.

The rest of the world also experienced lackluster growth in 2016. The pace of growth edged down in China, where the government reported the economy grew 6.7 percent in 2016—the slowest growth rate in 26 years. In the euro area, GDP growth slipped to 1.7 percent in 2016 and Japan’s economy expanded at only a 0.9 percent pace. A decline in business investment after the United Kingdom unexpectedly voted to initiate the process of withdrawing from the European Union (commonly referred to as Brexit) contributed to moderately slower GDP growth in the United Kingdom in 2016.

The result was generally more accommodative central bank policies around the globe. Central banks in Europe, Japan, the United Kingdom, and Brazil eased policies, while the US Federal Reserve—which at the start of the year had been widely expected to raise its key lending rate four times in 2016—only increased the federal funds rate once. The Federal Reserve’s less aggressive monetary policy stance, however, was not enough to offset further appreciation of the US dollar,* which rose 5.0 percent over the year as a whole. Although this factor, among others, weighed on American exports in 2016, reported 12-month earnings per share for the S&P 500 improved to $95 in 2016 from $87 in 2015.

* In this chapter, unless otherwise noted, the value of the US dollar is measured by the Trade Weighted US Dollar Index: Broad.

Global stock markets in 2016 were temporarily rattled by China’s currency devaluation in January, Brexit in June, and the US presidential election in November, but each time quickly settled down; average volatilities for the year as a whole were at the lower end of their historical ranges. At the start of 2016, global stock prices were decreasing, but most indexes had begun to rise by March and moved up further over the course of the year. In the United States, the S&P 500 advanced 9.5 percent, while the NASDAQ Composite Index gained 7.5 percent. In the United Kingdom, the Financial Times Stock Exchange (FTSE) 100 Index was up 14.4 percent for the year, and in Germany, the Deutscher Aktienindex (DAX) rose 6.9 percent. The MSCI Emerging Markets Index indicated that stock prices in emerging market countries also increased (8.6 percent) in 2016.

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 US long-term mutual fund assets (Figure 2.3). 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 94 million investors and that fund investors have a wide variety of individual characteristics (such as age or appetite for risk) and goals (such as saving for purchase of a home, for education, or for retirement). They also are 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 whole 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 2.5). The MSCI All Country World Daily Gross Total Return Index, a measure of returns on global stock markets, increased 8.5 percent in 2016, following a 1.8 percent decline in 2015. At the same time, equity mutual funds experienced net outflows totaling $260 billion in 2016 (or 3.2 percent of December 2015 assets), on the heels of $77 billion in net outflows in 2015.

Figure 2.5

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

Monthly, 2001–2016

Figure 2.5

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1 Net new cash flow is the percentage of previous month-end equity mutual 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

With the exception of February, equity funds had net outflows in every month in 2016 (Figure 2.6). In the first three months of the year, investors had redeemed, on net, only $6 billion* from equity funds. Flows to mutual funds, in general, tend to be higher in the first quarter than at other times of the year because investors who receive year-end bonuses may invest that money relatively quickly in the new year. In addition, some investors wait to make their tax-deductible contributions to their individual retirement accounts before filing their tax returns. As the year progressed, net outflows from equity funds accelerated with investors redeeming, on net, a total of $253 billion from April through December.

* Does not match sum of months shown in Figure 2.6 because of rounding.

Despite major US stock indexes hitting record highs and US stocks* returning 10.8 percent (including dividend payments) in 2016, domestic equity mutual funds had net outflows of $235 billion in 2016 (Figure 2.6). Volatility does not appear to have been a major factor in the outflows as the equity market was quiet, for the most part, over 2016. 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 2016, the daily VIX averaged 16, with the peak at 28 in mid-February.

* In this chapter, unless otherwise noted, the return on US stocks is measured by the Wilshire 5000 Total Return Index (float-adjusted).
Does not match sum of months shown in Figure 2.6 because of rounding.


Figure 2.6

Net New Cash Flow to Equity Mutual Funds in 2016

Billions of dollars; monthly, January 2016–December 2016

Figure 2.5

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* In March and May 2016, world equity mutual funds had net outflows of less than $500 million.
Note: Components may not add to the total because of rounding.

Rather than volatility, net outflows appear to have been driven primarily by assets shifting from domestic equity mutual funds into domestic equity exchange-traded funds (ETFs). As discussed in chapter 3, demand for ETFs has been very strong over the past several years. Although domestic equity ETFs, like domestic equity mutual funds, had net redemptions in January and February of 2016, demand for domestic equity ETFs strengthened rapidly over the rest of year. From March to December, net share issuance of domestic equity ETFs totaled $190 billion. In contrast, domestic equity mutual funds had net redemptions of $217 billion over the same 10-month period.

Before 2016, investors in the United States had increasingly diversified their portfolios toward equity mutual funds that invest significantly or primarily in foreign markets (world equity funds). In the decade from 2006 to 2015, domestic equity mutual funds experienced net outflows totaling $834 billion and world equity funds received net inflows of $643 billion.

This pattern seemed relatively insensitive to differences between domestic and world equity returns and changes in the US dollar exchange rate. For example, since 2010, US stocks have significantly outperformed international stocks.* From 2011 through 2015, domestic stocks returned an average of 9.8 percent per year compared with 1.5 percent per year for international stocks. Also, in 2015, the US dollar strengthened considerably over the year, and, though this development normally would have been expected to dampen overseas investment, world equity funds received $94 billion in net new cash, up from $85 billion in 2014.

* In this chapter, unless otherwise noted, the return on international stocks is measured by the MSCI All Country World ex-US Gross Total Return Index.

One factor that likely contributed to boosting flows to world equity funds 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 US investors had traditionally allocated to foreign investments. In addition, as the US 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.

Flows to world equity funds in 2016, however, defied what had become the norm as demand weakened considerably and investors redeemed, on net, $25 billion from world equity funds (Figure 2.6). The year started off fairly strong in January and February, with world equity funds receiving $21 billion in inflows—all of which went to international equity funds. Over the next 10 months, however, demand for world equity funds waned, with net outflows amounting to $46 billion.

Does not match sum of components shown in Figure 2.6 because of rounding.

A few developments ultimately may have prompted investors to pull back from world equity funds in 2016 after years of strong interest. First, the expected timeline for the global recovery was pushed out another year. China’s official reported GDP growth rates have ratcheted down consistently each year since 2010. In early spring 2016, China once again lowered its official economic growth target for the year. This reinforced concerns that a continued slowdown in the Chinese economy would further impede economic growth in emerging markets across Asia and Latin America due to weaker Chinese demand for imported goods and services. Elsewhere in the world, GDP forecasts for 2016 were marked down midyear as economic activity was weaker than expected. Second, returns on US stocks continued to outpace those of international stocks in 2016. Third, and perhaps most important, after retracing part of its run-up in 2015, the US dollar resumed its climb in May 2016 and ended the year at its highest level since early 2002.

Bond Mutual Funds

Bond fund flows typically are correlated with the performance of bonds (Figure 2.8), which, in turn, is largely driven by the US interest rate environment. In the first half of 2016, long-term interest rates declined about 80 basis points, likely reflecting weaker than expected economic activity and diminished prospects of tighter monetary policy. As economic activity picked up in the third quarter, long-term interest rates started to rise, then jumped after the US presidential election and continued to drift higher, ending the year at about 20 basis points more than at the beginning of 2016. These developments created a seesaw pattern (up first, then down) in the total return on bonds for the year. Bond mutual funds had net inflows of $107 billion in 2016, a significant reversal from $25 billion in net outflows in 2015.

Asset-Weighted Turnover Rate

The turnover rate—the percentage of a fund’s holdings that have been bought or sold over a year—is a measure of a fund’s trading activity. The rate is calculated by dividing the lesser of purchases or sales (excluding those of short-term assets) in a fund’s portfolio 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 are most heavily invested. 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 more assets, and accordingly, indicates the average portfolio turnover actually experienced by fund shareholders. In 2016, the asset-weighted annual turnover rate experienced by equity fund investors was 34 percent, well below the average of the past 33 years (Figure 2.7).

Investors tend to own equity funds with relatively low turnover rates. In 2016, about half of equity fund assets were in funds with portfolio turnover rates of less than 26 percent. This reflects the propensity for funds with below-average turnover to attract shareholder dollars.

Figure 2.7

Turnover Rate Experienced by Equity Mutual Fund Investors

1984–2016

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.


Figure 2.8

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

Monthly, 2001–2016

Figure 2.7

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1 Net new cash flow is the percentage of previous month-end bond mutual fund assets, plotted as a three-month moving average. Data exclude flows to high-yield bond mutual funds.
2 The 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 taxable bond mutual funds remained relatively strong throughout 2016, despite the increase in long-term interest rates in the second half of the year. For example, during the first half of 2016 when long-term interest rates were declining, taxable bond funds received $25 billion* in net new cash flow (Figure 2.9). During the second half of the year, investors added $59 billion,* on net, to taxable bond funds even though long-term interest rates were moving up. Certainly, bond fund investors reacted to the sharp jump in long-term interest rates after the US presidential election, but their response was mild, with only $6 billion (0.2 percent of October 2016 taxable bond fund assets) redeemed in November, on net.

* Does not match sum of months shown in Figure 2.9 because of rounding.

Investor demand varied across specific categories of taxable bond mutual funds in 2016. Investment grade bond funds (and multisector bond funds) were the most sought after, receiving $105 billion of net inflows in 2016. Government bond funds had $11 billion in net new cash flow and high-yield bond funds received $7 billion in 2016. In contrast, investors redeemed $40 billion, on net, from world bond funds, which typically hold a mix of bonds denominated in US dollars and foreign currencies. These outflows from world bond funds were, in part, attributable to a stronger US dollar. Appreciation in the US dollar reduces dollar returns on bonds denominated in foreign currencies and makes it more expensive for foreign companies to pay off their dollar-denominated debts.

Demand for municipal bond funds was fairly steady through the first 10 months of 2016 with inflows amounting to $51 billion (Figure 2.9). Flows turned negative in November and December as investors likely responded to higher long-term municipal interest rates and uncertainty regarding the continuation of the tax-exempt status of municipal bonds in any future tax reform overhaul. Investors redeemed, on net, $11 billion in November and $18 billion in December from municipal bond funds. These net outflows represented 4.3 percent of municipal bond fund assets as of October 2016.

Figure 2.9

Net New Cash Flow to Bond Mutual Funds in 2016

Billions of dollars; monthly, January 2016–December 2016

Figure 2.8

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

How Bond Mutual Funds Manage Investor Flows

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

First, although US bond mutual fund assets have risen in the past decade, bond mutual fund assets were only 10 percent of the US bond market (US government bonds, corporate bonds, and tax-exempt bonds) in December 2016, up from 7 percent at year-end 2006. This means that 90 percent of the US bond market is held by investors outside of mutual funds.

Second, bond mutual fund managers have other means of meeting redemption requests than selling bonds. Each day, bond mutual funds receive cash in the form of interest income from bonds held in the portfolio and proceeds from matured bonds. Also, mutual funds in general have cash coming in from new sales of fund shares on any given day. Bond fund managers can often fulfill the vast majority of redemption requests using these cash sources.

In addition, bond fund managers employ a wide range of strategies to prepare to meet shareholder redemptions, including holding short-term assets or using derivatives. Derivatives can be more liquid than their physical counterparts. Funds are required to segregate liquid assets to support their derivatives positions. As these positions are closed, this cash collateral provides a ready source of liquidity to meet redemptions. This is especially true for many funds referred to as liquid alternative funds, which are explicitly designed to allow frequent investor trading, and do so in large measure through derivatives.

Finally, when meeting redemptions, managers use a nuanced approach in their bond trading, with their actions guided by market conditions, expected investor flows, and other factors. For example, during a market downturn, a manager might determine that the fund can add shareholder value by buying some less-liquid bonds. With liquidity at a premium, the manager might judge that the prices of such bonds are depressed relative to their fundamental values and thus represent a buying opportunity. On the other hand, the fund might seek to add shareholder value by selling some of its more-liquid bonds (which, being in high demand, are trading at a premium to fundamental value). Other fund managers may conclude that it is necessary and appropriate to meet outflows by selling a “slice” of the fund’s portfolio.

Despite several periods of market turmoil, bond mutual funds have experienced net inflows through most of the past decade. Bond funds received $2.0 trillion in net inflows and reinvested dividends from 2007 through 2016 (Figure 2.10). A number of factors have helped sustain this long-term demand for bond mutual funds.

Figure 2.10

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

Cumulative flows to bond mutual funds, billions of dollars; monthly, January 2007–December 2016

Figure 2.10

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Note: Bond mutual fund data 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 mutual 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 net outflows from bond funds would have been expected when long-term interest rates rose over the second half of 2016, they were likely mitigated, in part, by the demographic factors that have supported 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 2016. Target date 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 from equities to fixed-income investments, including bonds. Target date 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 funds have received net inflows of $509 billion. In 2016, target date funds had net inflows of $65 billion and ended the year with assets of $887 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. The adoption of the Pension Protection Act of 2006 and the Department of Labor’s regulations encouraging target date funds as default investments for DC plans also contributed to their growth.

Hybrid Mutual Funds

Over the past 10 years, investors added $192 billion in net new cash flow to hybrid funds, which were an increasingly popular way to help investors achieve a managed, balanced portfolio of stocks and bonds (Figure 2.11). In 2016, however, investors redeemed, on net, $46 billion (or 3.4 percent of prior year-end assets), following $21 billion in net redemptions in 2015.

Figure 2.11

Net New Cash Flow to Hybrid Mutual Funds

Billions of dollars; annual, 2007–2016

Figure 2.11

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Hybrid funds (also called asset allocation funds or balanced funds) invest in a mix of stocks and 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.

Net outflows in 2016 from hybrid funds were concentrated in “flexible portfolio” funds, which can hold any proportion of stocks, bonds, cash, and commodities, both in the United States and overseas. In many ways, the 2007–2009 financial crisis evoked a desire among 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. However, after a long bull market and comparably lower returns in funds offering downside protection, investors redeemed, on net, $22 billion in 2015 and $35 billion in 2016 from flexible portfolio hybrid funds.

The Growth of Other Investment Products

Some of the outflows from long-term mutual funds in 2016 reflect a broader shift, driven by both investors and retirement plan administrators, 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 2016, 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, 35 percent owned at least one equity index mutual fund in 2016. As of year-end 2016, 421 index mutual funds managed total net assets of $2.6 trillion. For 2016 as a whole, investors added $197 billion in net new cash flow to these funds (Figure 2.12). Of the new money that flowed to index mutual funds, 43 percent was invested in funds tied to domestic stock indexes, 34 percent was invested in funds tied to bond or hybrid indexes, and 23 percent went to funds tied to world stock indexes. Assets in index equity mutual funds made up 25 percent of all equity mutual fund assets in 2016 (Figure 2.13).

Figure 2.12

Net New Cash Flow to Index Mutual Funds

Billions of dollars; annual, 2007–2016

Figure 2.12

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


Figure 2.13

Index Equity Mutual Funds’ Share Continued to Rise

Percentage of equity mutual funds’ total net assets; year-end, 2001–2016

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 2016, index domestic equity mutual funds and ETFs received $1.4 trillion in net new cash and reinvested dividends, while actively managed domestic equity mutual funds experienced a net outflow of $1.1 trillion (including reinvested dividends) (Figure 2.14). Index domestic equity ETFs have grown particularly quickly—attracting one and a half times the net inflows of index domestic equity mutual funds since 2007. Part of the recent increasing popularity of ETFs is likely attributable to more brokers and financial advisers using them in their clients’ portfolios. In 2015, full-service brokers and fee-based advisers had 11 percent and 17 percent, respectively, of their clients’ household assets invested in ETFs, up from 6 percent and 10 percent in 2011 (Figure 2.15).

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 2016

Figure 2.14

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* Prior to October 2009, index domestic equity ETF data include a small number of actively managed domestic equity ETFs.
Note: Equity mutual fund data include net new cash flow and reinvested dividends. Data exclude funds that invest primarily in other funds.


Figure 2.15

Fee-Based Advisers Are Driving Larger Portions of Client Portfolios Toward ETFs

Percentage of household assets invested in investment category by adviser type, 2011 and 2015

Figure 2.15

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1 This category includes wirehouses as well as regional, independent, and bank broker-dealers.
2 This category includes registered investment advisers and dually registered investment adviser broker-dealers.
3 This category excludes an unknown portion of assets from investors who received fee-based advice but implemented trades themselves through discount brokers and fund supermarkets.
Source: Cerulli Associates

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, which can limit the costs of managing pooled investment products. Unlike mutual funds, which are regulated under the Investment Company Act of 1940, CITs are regulated under banking laws and are not marketed as widely as mutual funds; this can also reduce their operational and compliance costs as compared with mutual funds.

More retirement plan sponsors have begun offering CITs as options in 401(k) plan lineups. As Figure 2.16 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 17 percent in 2015. This recent expansion is due, in part, to the growth in target date fund CITs.

Figure 2.16

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, selected years

Figure 2.16

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Note: Assets exclude Direct Filing Entity (DFE) assets that are reinvested in collective investment trusts. Data prior to 2015 come from the Form 5500 Research data sets released by the Department of Labor. Data for 2015 are preliminary, based on Department of Labor 2015 Form 5500 raw data sets.
Source: Investment Company Institute tabulations of Department of Labor Form 5500 data

Demand for Money Market Funds

In 2016, investors redeemed, on net, $30 billion from money market funds. This modest topline net outflow for the year, however, masks significant shifts in flows for different types of money market funds that was spurred by the final implementation of new rules governing money market funds (see here). In 2016, government money market funds received $851 billion in net inflows, while prime and tax-exempt money market funds saw net redemptions of $765 billion and $116 billion, respectively (Figure 2.17).

Figure 2.17

Net New Cash Flow to Money Market Funds

Billions of dollars; monthly, January–December 2016

Figure 2.16

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* In October and December 2016, tax-exempt money market funds had net flows of less than $500 million.
Note: Components may not add to the total because of rounding.

Recent Reforms to Money Market Funds

In July 2014, the SEC adopted additional rules for money market funds. All money market funds were required to comply with the new rules by October 14, 2016. The new rules largely centered around two key reforms. First, nongovernment (prime and tax-exempt) money market funds that are sold to institutional investors must price and transact their shares to the nearest one-hundredth of a cent (i.e., float their net asset values [NAVs]). Additionally, all prime and tax-exempt money market funds, whether retail or institutional, can impose gates (i.e., temporarily halt redemptions) or redemption fees on redeeming shareholders under limited situations. A fund is required to impose redemption fees if the fund’s weekly liquid assets fall below 10 percent of its total assets, unless the fund’s board decides a redemption fee is not in the best interest of the fund’s shareholders.

These rules clearly had an impact on investor demand for money market funds beginning in late 2015. The changes pushed investors toward government money market funds—those that invest principally in securities issued by the US Treasury or government agencies (or repurchase agreements backed by government securities). Institutional investors that preferred money market funds with stable $1.00 NAVs appear to have moved from prime to government money market funds. From October 2015 through October 2016, assets in prime institutional money market funds fell $814 billion (Figure 2.18). Over the same period, assets in government institutional money market funds rose by $772 billion.

A similar, though muted, shift occurred in retail money market funds. From October 2015 to October 2016, assets in prime retail money market funds dropped by $262 billion (Figure 2.18) and assets in tax-exempt money market funds—the vast majority of which are held by retail investors—fell $117 billion. In contrast, assets of retail government money market funds rose by $371 billion.

Under the new rules, prime and tax-exempt retail money market funds may continue to transact at stable $1.00 NAVs. Thus, the shift in retail money market fund assets was not related to floating the NAV. Rather, the requirement that all nongovernment money market funds (including prime and tax-exempt retail money market funds) must now be able to impose redemption fees and gates pushed retail investors toward government money market funds. Before the rule change, prime and tax-exempt money market funds were often used as “sweeps” in brokerage accounts. In a sweep arrangement, any available client funds not yet needed to pay for investments generally are moved daily into a money market fund so that the investor is fully invested at all times. Broker-dealers with sweep arrangements reportedly moved client assets from prime retail and tax-exempt money market funds to government money market funds to avoid the possibility that clients would not be able to fulfill settlement obligations for securities transactions if a gate or redemption fee were imposed on their prime or tax-exempt money market fund.

Figure 2.18

Assets Migrated from Prime Money Market Funds into Government Money Market Funds in 2015 and 2016

Total net assets, billions of dollars; month-end, January 2015–December 2016

Figure 2.17

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Orderly Transition to Government Money Market Funds

This massive shift in assets between prime money market funds and government money market funds proceeded smoothly. Prime money market funds prepared for the October 14, 2016, deadline by investing predominantly in securities with very short maturities, which made their portfolios extremely liquid. The weighted average maturity (WAM) on prime money market funds fell from 33 days in mid-October 2015 to 14 days in early October 2016, about 10 days before the deadline (Figure 2.19). Similarly, the weighted average life (WAL) dropped from 59 days to 24 days over the same period. With the shorter maturities, prime money market funds had ample liquidity to accommodate high levels of outflows. Prime money markets funds’ WAMs and WALs increased after the October 14, 2016, deadline passed, but remained low in comparison to levels before October 2015.

Figure 2.19

Prime Money Market Funds Shortened Maturities Before October 14, 2016, Deadline

Number of days; weekly, January 6, 2015–December 27, 2016

Figure 2.19

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Source: iMoneyNet

As assets in government money market funds rose, those funds’ demand for government securities (and repurchase agreements backed by government securities) jumped sharply. The market accommodated the increased demand for government securities in good order. From October 2015 to October 2016, the US Treasury added $480 billion to the supply of Treasury bills, in part to fund a significant increase in the Treasury’s cash balance. In addition, the Federal Home Loan Banks increased their issuance of floating rate notes, which government money market funds can hold. Government money market funds also can place dollars with the Federal Reserve’s overnight reverse repurchase agreement (ON RRP) facility, which allows money market funds to make collateralized overnight loans to the Federal Reserve, earning interest on those loans. In the month leading up to the October 14, 2016, deadline, the ON RRP facility expanded with an average of $464 billion in overnight lending—this amount was about $145 billion higher than the comparable period in 2015.

Unsurprisingly, the composition of assets held by taxable money market funds at the end of 2016 was vastly different than it was before the shift from prime into government funds, even though total assets of taxable money market funds were little changed. In October 2015, taxable money market funds had $2.5 trillion in assets; by year-end 2016, total assets had grown modestly to $2.6 trillion (Figure 2.20). In October 2015, 15 percent of taxable money market funds’ portfolio securities were invested in commercial paper and 55 percent was invested in government securities, including repurchase agreements backed by government securities. As of December 2016, commercial paper accounted for a much smaller proportion (4 percent) and government securities a substantially larger proportion (88 percent) of portfolio securities held by taxable money market funds. Taxable money market funds’ commercial paper holdings fell $232 billion over the period and their share of the commercial paper market shrank significantly (Figure 1.6). Despite a sizable reduction in holdings of commercial paper by money market funds, the overall commercial paper market was minimally affected over this period. Seasonally adjusted total outstanding commercial paper declined only $37 billion from $1,027 billion in October 2015 to $990 billion in December 2016, as other buyers entered the commercial paper market in place of prime money market funds.

Figure 2.20

The Share of Government Securities in Taxable Money Market Fund Portfolios Has Risen Sharply

Percentage of portfolio securities of taxable money market funds, October 2015 and December 2016

Figure 2.19

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* Total net assets includes portfolio securities, cash, liabilities, receivables, and payables.
Note: Components may not add to 100 percent because of rounding.
Source: Investment Company Institute tabulations of SEC Form N-MFP data

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