Investors in U.S. equity mutual funds are rushing for the exits as if the house is about to burn down, which will inevitably knock out a key support for the stock market rally … at least that’s the bearish story.
But not so fast.
True, net outflows of domestic stock funds totaled another $4.2 billion in the week ending October 12th, according to industry data. This brings the year-to-date total of fund outflows to a whopping $108 billion, fast approaching last year’s record redemptions of $116 billion … and with two and a half months still to go.
But here’s the rest of the story.
Mutual fund outflows are part of a much larger trend that’s been underway for several years in financial markets. And far from a bearish tale, it’s a story of investors seeking lower fees and better performance in a world of lackluster investment returns.
The reality, as you can see illustrated in the graph above, is that these outflows aren’t getting stashed under mattresses. The money is transitioning from actively managed funds into passive, index-tracking investments instead.
And the most notable winners of this flow are exchange-traded funds (ETFs).
Consider that U.S.-listed ETFs attracted $6.8 billion in new money last week, easily covering the $4.2 billion in mutual fund outflows, with a couple billion to spare. Year-to-date, U.S. ETFs have taken in a cool $164 billion, half of which has gone into bond funds.
The astonishing growth in ETFs is at the crest of a tidal wave of investor money that’s moving into passive funds, and it’s easy to see why.
Actively managed stock funds charge management fees of about 1% on average, compared to index-tracking ETFs with fees that are routinely 75% to 80% cheaper!
And to add insult to injury, not only are actively managed funds more expensive, but also their investment returns have routinely lagged the indexes, and index-tracking ETFs.
In other words, for years retail investors paid-up for poor performance in mutual funds, but no more. ETFs and other low-cost index funds are quickly gobbling up market share today.
Just look at the scorecard below showing the year-by-year totals of money flowing into passive funds and out of active funds.
The largest player in passive, index-fund management is Vanguard. Over the past year alone, Vanguard has taken in a staggering $234 million in assets for its index-tracking funds and ETFs.
By contrast, some of the largest actively managed mutual fund companies in America are seeing steady outflows.
Boston’s storied Fidelity Investments, the largest active fund management company, had outflows of $40.8 billion over the past year. Rival Franklin Templeton has lost $44.8 billion in assets, while T. Rowe Price had outflows of $15 billion.
Bottom line: Don’t let perma-bears spook you with stories about a coming stock market collapse just because massive amounts of money are flowing out of mutual funds. That money is staying invested in stocks (and bonds). It’s just rationally transitioning into lower-cost and better-performing investment choices, mainly ETFs. What’s more, if you take a closer look at the funds you hold in your own retirement accounts, then you may decide you can save money and boost your returns by joining this trend.