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This chapter describes recent U.S. mutual fund developments and examines the market factors that affect the demand for equity, bond, hybrid, and money market funds.

With $15 trillion in assets, the U.S. mutual fund industry remained the largest in the world at year-end 2013. Total net assets increased by nearly $2 trillion from the level at year-end 2012, boosted primarily by growth in equity fund assets. Net new cash flow into all types of mutual funds totaled $167 billion in 2013. Investor demand for certain types of mutual funds appeared to be driven, in large part, by improving economic conditions in the United States and Europe, strong stock market performance, rising long-term interest rates, continued popularity of index funds, and the demographics of the U.S. population. Reversing five years of consecutive withdrawals, equity funds experienced strong inflows in 2013. In contrast, investors redeemed, on net, from bond funds for the first time since 2004. Hybrid funds remained popular, with inflows increasing again in 2013. After four years of outflows, money market funds experienced modest net inflows of $15 billion.

Investor Demand for U.S. Mutual Funds

Investor demand for mutual funds is influenced by a variety of factors, not least of which is 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 U.S. mutual fund market—with $15 trillion in assets under management at year-end 2013—remained the largest in the world, accounting for half of the $30 trillion in mutual fund assets worldwide (Figure 2.1).

The majority of U.S. mutual fund assets were in long-term funds. Equity funds made up 52 percent of U.S. mutual fund assets at year-end 2013 (Figure 2.1). Domestic equity funds (those that invest primarily in shares of U.S. corporations) held 38 percent of total industry assets. World equity funds (those that invest primarily in non-U.S. corporations) accounted for another 14 percent. Bond funds accounted for 22 percent of U.S. mutual fund assets. Money market funds (18 percent) and hybrid funds (8 percent) held the remainder.

More than 800 sponsors managed mutual fund assets in the United States in 2013. Long-run competitive dynamics have prevented any single firm or group of firms from dominating the market. For example, of the largest 25 fund complexes in 2000, only 13 remained in this top group in 2013. Another measure of market concentration is the Herfindahl-Hirschman Index, which weighs both the number and relative size of firms in the industry. Index numbers below 1,000 indicate that an industry is unconcentrated. The mutual fund industry had a Herfindahl-Hirschman Index number of 481 as of December 2013.

Figure 2.1

The United States Has the World’s Largest Mutual Fund Market

Percentage of total net assets, year-end 2013

Figure 2.1

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Source: International Investment Funds Association

Nevertheless, the percentage of industry assets at larger fund complexes has increased since 2000. The share of assets managed by the largest 10 firms in 2013 was 53 percent, up from the 44 percent share managed by the largest 10 firms in 2000 (Figure 2.2). In addition, the share of assets managed by the largest 25 firms was 72 percent in 2013 compared with 68 percent in 2000.

Figure 2.2

Share of Assets at the Largest Mutual Fund Complexes

Percentage of total net mutual fund assets; year-end, selected years

  1995 2000 2005 2010 2011 2012 2013
Largest 5 complexes 34 32 37 40 40 40 40
Largest 10 complexes 47 44 48 53 53 53 53
Largest 25 complexes 70 68 70 74 73 73 72

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Note: Household financial assets held in registered investment companies include household holdings of ETFs, closed-end funds, UITs, and mutual funds. Mutual funds held in employer-sponsored DC plans, IRAs, and variable annuities are included.
Sources: Investment Company Institute and Federal Reserve Board

Several factors likely contributed to this development. One factor is the acquisition of smaller fund complexes by larger ones. In addition, actively managed domestic equity mutual funds incurred outflows for eight consecutive years, while index domestic equity funds had inflows in each of these years. The 10 largest fund complexes manage most of the assets of index mutual funds. Also, strong inflows over the decade to bond funds, which are fewer in number and have fewer fund sponsors than equity mutual funds, helped boost the share of assets managed by those large fund complexes that offer bond funds. Finally, total returns on bonds* averaged 5.3 percent annually in the past 13 years.

* Measured by the Citigroup Broad Investment Grade Bond Index.

Developments in Mutual Fund Flows

Overall demand for mutual funds as measured by net new cash flow—new fund sales less redemptions combined with net exchanges—slowed in 2013. Increased demand for equity, hybrid, and money market mutual funds was more than offset by lower demand for bond funds. Overall, mutual funds had a net cash inflow of $167 billion in 2013, down from $196 billion in 2012 (Figure 2.3). Investors added $152 billion, on net, to long-term funds, and $15 billion, on net, to money market funds. Actions by the Federal Reserve, global economic conditions, evolving investment preferences, and ongoing demographic trends appeared to influence mutual fund flows in 2013.

Figure 2.3

Net New Cash Flow to Mutual Funds

Billions of dollars, 2000–2013

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 2013

Economic conditions in the United States improved significantly in 2013, as what had been a sluggish and uneven economic recovery began to show signs of durable improvement. Although 2013 began with a significant fiscal consolidation through tax increases and weaker government spending, the U.S. economy expanded at a 1.9 percent average annual growth rate in 2013. Growth was particularly strong during the third quarter, when real GDP increased at a 4.1 percent annual rate. Gains in inventory, consumer spending, and exports helped the U.S. economic expansion continue into the fourth quarter despite a 16-day government shutdown and debt ceiling impasse in October. Overall, annualized real GDP growth averaged 3.3 percent over the second half of 2013. In addition, the unemployment rate fell from 7.9 percent at the end of 2012 to 6.7 percent at the end of 2013 and corporate profits continued to rise. Home prices* rose 13.6 percent in 2013, the largest 12-month gain since 2006, and stock indexes registered record highs. In particular, prices of S&P 500 companies rose by 30 percent over the year. Gains in stocks and home values helped lift household net worth to record levels.

In the second half of 2013, prices on bonds declined and long-term interest rates rose. From April 30 to early July 2013, yields on long-term bonds (as measured by the yield on the 10-year Treasury note) jumped more than 100 basis points. This rise in rates largely reflected perceptions that the economy was strengthening and that the Federal Reserve might soon reduce its program of large-scale purchases of bonds (known as QE3). Market participants’ expectations solidified in late May to mid-June following comments by Federal Reserve officials, which market participants interpreted as confirming QE3 would soon be scaled back. Consequently, from April 30, 2013, to August 30, 2013, total returns on bonds fell 3.6 percent, the largest four-month decline since the bond market rout in 1994.

* Measured by the S&P/Case-Shiller home price index.
† Measured by the Citigroup Broad Investment Grade Bond Index.

Economic and financial conditions in emerging market economies hit a speed bump in 2013. In recent years, rapid industrialization in parts of the developing world, particularly in Asia, stoked demand for commodities, many of which come from emerging markets. Meanwhile, low interest rates in the developed world encouraged foreign investment in emerging market economies, fueling further economic expansion. In 2013, however, slower rates of economic growth, particularly in China, lowered demand for commodities and higher long-term interest rates in the United States increased the attractiveness of U.S. fixed-income securities, putting upward pressure on the U.S. dollar. In turn, for emerging market borrowers, the rising value of the U.S. dollar raised the cost in local currency of servicing U.S. dollar–denominated debt. Interest rates in developing countries climbed and prices on emerging markets stocks* fell by 5 percent in 2013 after rising at an average annual rate of nearly 9 percent during the last decade.

Economic and financial conditions in the eurozone continued to improve in 2013. The overall eurozone economy emerged from recession and began to grow in the second quarter of 2013, boosted by a rebound in two of the region’s largest economies—Germany and France—and an easing of the recessions in Italy and Spain. Bond credit spreads in the euro-area periphery declined and European stock priceswere up 20 percent for the year. Nonetheless, high unemployment and fiscal austerity in the eurozone continued to hold GDP growth in check.

Long-Term Mutual Fund Flows

Global economic conditions, market returns, and the Federal Reserve’s actions had an important impact on mutual fund flows in 2013. Investors added $152 billion in net new cash flow to equity, bond, and hybrid funds in 2013. The composition of these flows differed substantially from recent years, however, with equity funds experiencing net inflows of $160 billion and bond funds experiencing net outflows of $80 billion. Hybrid funds, which invest in a mix of stocks and bonds, recorded positive net new cash flows for the fifth straight year.

* Measured by the MSCI Emerging Markets Index.
† Measured by the MSCI Europe Index.

Equity Mutual Funds

Relative outperformance of equities, coupled with lower stock market volatility, helped bolster steady demand for equity mutual funds throughout 2013.

Demand for equity funds is generally positively correlated with stock market performance (Figure 2.4). Net flows to equity funds tend to rise with stock prices and the opposite tends to occur when stock prices fall. In 2013, flows to equity mutual funds appeared to have resumed this historical relationship with global stock returns after five years of weak demand despite strong equity returns over most of that period. In 2013, the return on the MSCI All Country World Daily Total Return Index, a measure of returns (including dividend payments) on global stock markets, was 23 percent and equity mutual funds received net inflows totaling $160 billion. Indeed, equity funds received positive net new cash flows in each month of 2013 except for December, although the strength of the flow varied throughout the year (Figure 2.5). This development is in contrast to the previous five years, 2008 to 2012, in which equity mutual funds experienced cumulative outflows of $537 billion, an average of $107 billion per year.

Figure 2.4

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

Monthly, 2000–2013

Figure 2.4

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1 Net new cash flow is 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 Total Return Index.
Sources: Investment Company Institute and Morgan Stanley Capital International

Figure 2.5

Net New Cash Flow to Long-Term Mutual Funds

Billions of dollars, September 2012–December 2013

Figure 2.5

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* In December 2013, investors added $406 million to hybrid funds and withdrew $182 million from equity funds.
Note: Components may not add to the total because of rounding.

Lower stock market volatility also likely served to strengthen demand for equity mutual funds. 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 above 30 typically reflect a high degree of investor fear and values below 20 are associated with a period of market calm. In 2013, the VIX averaged 14 and peaked at 20. These levels are well below those of recent years. For example, in 2011 and 2012, the VIX averaged 24 and 18, respectively, and peaked at levels of 48 and 27, respectively.

Lower stock market volatility also may have had a positive impact on investors’ willingness to take above-average or substantial investment risk in 2013. In the wake of the 2007–2008 financial crisis, U.S. household surveys taken each May showed a decline in willingness to take above-average or substantial investment risk for equivalent levels of financial gain (Figure 2.6). In 2008, 23 percent of households were willing to take above-average or substantial investment risk. From 2009 through 2012, this level dropped to 19 percent. In contrast, the percentage of households willing to take below-average or no risk rose over this same period, from 40 percent in 2008 to 46 percent in 2012. In 2013, households’ willingness to take above-average or substantial investment risk increased to 21 percent, while risk aversion (as measured by the percentage of households willing to take only below-average or no risk) declined to 43 percent.

Figure 2.6

Willingness to Take Investment Risk

Percentage of U.S. households, 2008–2013

Figure 2.6

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Note: This figure measures willingness to take investment risk for equivalent gain—for example, willingness to take above-average or substantial risk for above-average or substantial gain.

Investors in the United States increasingly have diversified their portfolios toward equity mutual funds that invest significantly or primarily in foreign markets (world equity funds). Over the past 10 years, world equity funds received cumulative inflows of $626 billion, while domestic equity mutual funds experienced outflows totaling $487 billion over the same period. In 2013, while world equity funds received the bulk ($142 billion) of the net new cash to equity mutual funds, domestic equity funds received $18 billion, their first inflow after seven consecutive years of outflows. Also, despite higher interest rates and a stronger U.S. dollar, equity mutual funds that specialize in emerging markets attracted $33 billion in new cash in 2013.

The strong demand for world equity funds over the past decade also likely reflects the high returns that have been realized in overseas markets. Both international and domestic stocks have returned an average of 8 percent annually over the past 10 years. However, between 2003 and 2012, international stocks, on average, performed better than domestic stocks. In 2013, U.S. stocks significantly outperformed international stocks. The total return on the Wilshire 5000 index, an index of U.S. stock market performance, was 34 percent, while the total return on international stocks* was 16 percent. These relative rates of return contributed, in part, to the turnaround in domestic equity mutual fund flows in 2013.

* Measured by the MSCI All Country World ex-U.S. Index.

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 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 large amounts of assets, and accordingly, indicates the average portfolio turnover actually experienced by fund shareholders. In 2013, the asset-weighted annual turnover rate experienced by equity fund investors was 41 percent, well below the average of the past 34 years.

Investors tend to own equity funds with relatively low turnover rates. In 2013, about half of equity fund assets were in funds with portfolio turnover rates of less than 29 percent. This reflects the propensity for funds with below-average turnover to attract shareholder dollars.

Figure 2.7

Turnover Rate Experienced by Equity Fund Investors

1980–2013

Figure 2.7

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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

In 2013, bond fund flows were heavily influenced by developments related to monetary policy. Bond fund flows are typically highly correlated with the performance of bonds (Figure 2.8), which, in turn, is primarily driven by the U.S. interest rate environment. Throughout 2013, the Federal Reserve continued to hold short-term interest rates at a very low level and also continued to make large-scale purchases of fixed-income securities under QE3. In the second half of May, however, comments by Federal Reserve officials were interpreted by the markets as an indication that the Federal Reserve might begin to curtail its asset purchases. Following those comments, long-term interest rates rose sharply, depressing returns in the U.S. fixed-income market.

Figure 2.8

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

Monthly, 2000–2013

Figure 2.8

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1 Net new cash flow to bond funds is plotted as a three-month moving average of net new cash flow as a percentage of previous month-end assets. Data exclude flows to high-yield bond 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 and Citigroup

Demand for bond funds fell in the second half of 2013 in response to negative returns on bonds from higher long-term interest rates (Figure 2.5). In the first five months of 2013, bond funds received net cash inflows totaling $90 billion. But from June through December, investors redeemed $170 billion, on net, from bond funds (both taxable and tax-exempt). For 2013 as a whole, bond funds experienced net cash outflows of $80 billion—the first annual outflow since 2004. This outflow, however, is relatively small—representing only 2.4 percent of bond fund total net assets as of December 2012. This experience is in contrast to 1994 when a similar decline in bond fund returns resulted in outflows of 10.1 percent of bond funds’ assets. In addition, putting the $80 billion outflow in 2013 in further perspective, from 2005 to 2012, bond funds received cumulative inflows of $1.2 trillion. In 2012 alone, bond funds received $302 billion in net inflows.

Several factors, such as demand for shorter duration fixed-income securities, demographics, and the increasing use of target date funds, likely tempered aggregate outflows from bond funds in 2013.

Investors sought to mitigate capital losses associated with rising long-term interest rates by moving into bond funds with shorter durations. Bond funds most susceptible to increases in long-term interest rates, namely those that invest primarily in longer-term bond funds with higher durations—such as those whose investment mandates focus on mid- to long-term Treasury bonds, corporate bonds, or mortgage-backed securities—had outflows of $41 billion. These outflows, however, were partially offset by strong investor demand for short-term bond funds, which are less likely to experience significant capital losses in response to rising long-term interest rates. In 2013, corporate and government short-term bond funds accumulated net cash inflows of $33 billion. Overall, taxable bond funds had net outflows of $22 billion in 2013.

The changing interest rate environment in 2013 also influenced the demand for tax-exempt bond funds. However, redemptions from tax-exempt bond funds in 2013 were likely exacerbated by investor concerns about the finances of state and local governments. In 2013, tax-exempt bond funds had $58 billion in outflows. By comparison, these funds had inflows of $50 billion in 2012. Large bankruptcies have been rare in the municipal bond market. However, the fiscal position of many state and local governments deteriorated during the past several years, in part because of lower tax revenues following the collapse of the housing market during the financial crisis. In addition, the extremely low interest rates maintained by the Federal Reserve in the wake of the financial crisis raised the cost to municipalities of funding defined benefit plans. In July 2013, Detroit filed for bankruptcy protection, the largest municipality in U.S. history to do so. This raised concerns that these events might affect other municipalities in Michigan and that there might be legal implications for municipalities in other states.

Nevertheless, the aging of the U.S. population may have served to moderate bond fund outflows in 2013, just as it likely helped to boost bond inflows in the past decade. Surveys indicate that as investors age, their willingness to take investment risk tends to decline. In 2013, for example, 24 percent of households in which the head was aged 35 to 49 indicated that they were willing to take above-average or substantial investment risk (Figure 2.9). In comparison, for households headed by someone aged 65 or older, only 14 percent were willing to take such investment risks.

Figure 2.9

Willingness to Take Above-Average or Substantial Investment Risk by Age Group

Percentage of U.S. households by age of head of household, 2013

Figure 2.9

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Note: Age is based on the age of the sole or co-decisionmaker for household saving and investing. This figure measures willingness to take investment risk for equivalent gain—for example, willingness to take above-average or substantial risk for above-average or substantial gain.

Older investors also tend to have higher account balances because they have had more time to accumulate savings and take advantage of compounding. For example, in 2013, households in which the head was younger than 35 held just 4 percent of mutual fund assets, whereas households in which the head was 55 to 64 held 32 percent of mutual fund assets (Figure 2.10). Larger mutual fund holdings of older age groups, combined with the tendency of investors to shift toward fixed-income products as they approach retirement, implies an underlying demand for bond funds by older investors. This could partly offset a decline in demand for bond funds by other investors as a result of rising interest rates.

Figure 2.10

Mutual Fund Assets by Age Group

Percentage of households’ mutual fund assets, selected years

Figure 2.10

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Note: Age is based on the age of the sole or co-decisionmaker for household saving and investing.

The continued popularity of target date mutual funds also likely helped to reduce outflows from bond funds in 2013. Target date mutual funds invest in a changing mix of equities and bonds (and possibly other types of investments, such as commodities). 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 bonds. Target date mutual funds usually invest through a fund-of-funds approach, meaning they primarily hold and invest in shares of other stock and bond mutual funds. In 2013, target date mutual funds had inflows of $53 billion and ended the year with assets of $618 billion, up from $481 billion in 2012. 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 plans. Also, following the adoption of the Pension Protection Act of 2006, many defined contribution plans have selected target date funds as a default option for the investments of newly enrolled plan participants (see chapter 7).

Hybrid Mutual Funds

With the exception of 2008, hybrid funds have seen inflows every year in the past decade. Hybrid funds, also 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 65 percent of the fund’s assets in equities and 35 percent in bonds. This approach offers a way to balance the potential capital appreciation of common 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 seven years, investors have added $384 billion in net new cash and reinvested dividends to these funds (Figure 2.11). In 2013 alone, investors added a record $73 billion in net new cash flow to hybrid funds, up from $47 billion in 2012.

Figure 2.11

Investors Are Gravitating Toward Hybrid Funds

Cumulative flows to hybrid mutual funds, billions of dollars; monthly, 2007–2013

Figure 2.11

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

The Growing Popularity of Index Funds

Index funds also remained popular with investors. Of households that owned mutual funds, 30 percent owned at least one index mutual fund in 2013. As of year-end 2013, 372 index funds managed total net assets of $1.7 trillion. Demand for index mutual funds remained strong in 2013, with investors adding $114 billion in net new cash flow to these funds (Figure 2.12). Of the new money that flowed to index mutual funds, 46 percent was invested in funds tied to domestic stock indexes, 25 percent went to funds tied to world stock indexes, and another 30 percent was invested in funds tied to bond or hybrid indexes, such as those commonly used to benchmark target date mutual fund performance. Demand for index domestic equity mutual funds more than tripled in 2013, with these funds experiencing an aggregate inflow of $52 billion.

Index equity mutual funds accounted for the bulk of index mutual fund assets at year-end 2013. Eighty-two percent of index mutual fund assets were invested in funds that track the S&P 500 or other domestic and international stock indexes (Figure 2.13). Mutual funds indexed to the S&P 500 managed 33 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 18.4 percent in 2013 (Figure 2.14).

Figure 2.12

Net New Cash Flow to Index Mutual Funds

Billions of dollars, 2000–2013

Figure 2.12

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

Figure 2.13

Funds Indexed to the S&P 500 Held 33 Percent of Index Mutual Fund Assets

Percent, year-end 2013

Figure 2.13

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Figure 2.14

Index Equity Mutual Funds’ Share Continued to Rise

Percentage of equity mutual funds’ total net assets, 2000–2013

Figure 2.14

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Index domestic equity mutual funds and index-based exchange-traded funds (ETFs), which are discussed in detail in chapter 3, have benefited from this trend toward more index-oriented investment products. From 2007 through 2013, index domestic equity mutual funds and ETFs received $795 billion in cumulative net new cash and reinvested dividends (Figure 2.15). Index-based domestic equity ETFs have grown particularly quickly—attracting roughly twice the flows of index domestic equity mutual funds since 2007. In contrast, actively managed domestic equity mutual funds experienced a net outflow of $575 billion, including reinvested dividends, from 2007 to 2013. Although redemptions from actively managed equity funds slowed significantly in 2013, likely due to strong U.S. stock returns, money continued to flow into index domestic equity mutual funds and ETFs at a fast pace.

Figure 2.15

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 ETFs, billions of dollars; monthly, 2007–2013

Figure 2.15

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Note: Equity mutual fund flows include net new cash flow and reinvested dividends.

Demand for Money Market Funds

In 2013, money market funds received ­a modest $15 billion—the first annual inflow since 2008. Demand for money market funds was not uniform throughout 2013, however. Various factors, including tax events, rising long-term interest rates, and a U.S. debt ceiling standoff, influenced money market fund flows during 2013.

Outflows from money market funds were concentrated in the first four months of 2013, during which investors redeemed $125 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. In addition, in early 2013, investors appeared to have unwound money market fund investments made near year-end 2012 as a result of uncertainties surrounding the fiscal cliff. In the last two months of 2012, money market funds received $145 billion in new cash as some investors sold equity mutual funds to lock in capital gains tax liabilities in anticipation that capital gains tax rates would increase in 2013. Also, in advance of increases in tax rates at the end of 2012, some corporations paid out hefty special dividends to stockholders and part of this cash was funneled to money market funds.

Figure 2.16

Net New Cash Flow to Money Market Funds

Billions of dollars, September 2012–December 2013

Figure 2.16

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* In September 2012, investors withdrew $106 million from prime money market funds; in August 2013, investors withdrew $202 million from government money market funds; and in November 2013, investors withdrew $414 million from tax-exempt money market funds.

After these tax-related influences waned in early 2013, outflows abated and money market funds received inflows of $129 billion over the second half of the year (Figure 2.16). Rising long-term interest rates over this period likely caused investors to divert some cash to money market funds to avoid capital losses in long-term bond funds by shifting toward shorter-horizon investments.

Net inflow into money market funds during the second half of 2013 was briefly interrupted in October by a prolonged U.S. government shutdown and a congressional stalemate over whether to raise the U.S. borrowing limit. Concern regarding the implications of a temporary suspension of debt payments on maturing short-dated Treasury securities by the U.S. government prompted investors to redeem $57 billion from government money market funds, which invest almost exclusively in U.S. Treasury and agency securities, in the first 16 days of October.

2014 Fund Reclassification

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

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.

For more information

See Fund Reclassification page in the data table section
2014 Open-End Mutual Fund Reclassification FAQs, available at www.ici.org/research/stats/iob_update/iob_faqs
Open-End Investment Objective Definitions, available at www.ici.org/research/stats/iob_update/iob_definitions

Retail Money Market Funds

Because of Federal Reserve monetary policy, short-term interest rates continued to remain near zero in 2013. 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 2.17). 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. Retail money market funds, which principally are sold to individual investors, saw an outflow of a little more than $12 billion in 2013, following an outflow of $1 billion in 2012 (Figure 2.18).

Figure 2.17

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

Monthly, 2000–2013

Figure 2.17

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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

Institutional Money Market Funds

Institutional money market funds—used by businesses, pension funds, state and local governments, and other large-account investors—had a net inflow of $27 billion in 2013, following an inflow of $1 billion in 2012 (Figure 2.18). Some of the cash generated by rising corporate profits in 2013 was likely held in money market funds as well as in bank deposits.

Figure 2.18

Net New Cash Flow to Retail and Institutional Money Market Funds

Billions of dollars, 2000–2013

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.

U.S. nonfinancial businesses are important users of institutional money market funds. In 2013, U.S. nonfinancial businesses’ portion of cash balances held in money market funds was 20 percent (Figure 2.19). This portion reached a peak of 37 percent in 2008 and has declined since then.

Figure 2.19

Money Market Funds Managed 20 Percent of U.S. Businesses’ Short-Term
Assets in 2013

Percent; year-end, 2000–2013

Figure 2.19

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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

Recent Reforms to Money Market Funds

In 2010, the U.S. Securities and Exchange Commission (SEC) significantly reformed Rule 2a-7, a regulation governing money market funds. Among other things, the 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 funds’ holdings of Treasury and agency securities and repos have risen substantially as a share of the funds’ portfolios, from 12 percent in May 2007 to a peak of 36 percent in November 2012. In December 2013, this share was 28 percent of prime fund assets, still more than double the value prior to the financial crisis and subsequent reforms (Figure 2.20). For more complete data on money market funds, see section 4 in the data tables.

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, 2000–2013

Figure 2.20

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