Chart o’ the Day: Low Rates are Killing Mutual Fund Performance

Earlier this morning, we looked at the most recent SPIVA data on five years’ worth of mutual fund performance. It wasn’t pretty.

In a new research note, Deutsche Bank looks at what it calls The Great Divide. It’s a musing on the idea that mutual fund flows are being driven almost entirely by Fed policy – bond-like stock funds and balanced funds took in a net $180 billion since 2010 but all stock funds lost (lost!) $300 billion in outflows at the same time.

Investors are in search of low volatility and current income, and terrified of anything that sounds like it’s “higher risk”. The boomers are older and they’re way less tantalized by upside than they are enticed by perceived safety.

Look at this:

Screen Shot 2016-07-28 at 10.52.54 AM

DB takes it a step further and looks at the dearth of outperforming mutual funds relative to their benchmarks and finds a correlation with what bond yields are doing…

In contrast to end-investors flows, active equity mutual funds and long-short hedge funds are positioned cyclically, in line with positive data surprises. With relative sector performance driven by rates and not traditional cyclical indicators, active funds have underperformed over this cycle. Indeed, longer term mutual fund performance is closely tied to the Fed’s policy bias measured by the difference between policy rates and a traditional Taylor rule, i.e., the extent of the Fed’s disconnect from growth and inflation data

Josh here – in the charts below, you’ll be blown away at the correlation between active alpha vs the S&P 500 and yields / Fed policy:

Screen Shot 2016-07-28 at 11.01.27 AM

Screen Shot 2016-07-28 at 11.09.11 AM

When rates (when, LOL) begin rising, could the cycle of serial underperformance end?

That depends on whether your believe it’s cyclical in the first place. There are secular problems for alpha-seekers as well, notably the lack of easily harvestable errors by the moms & pops who stopped trading as well as the very crowded, very talented, very well-armed pool of talent that now exists.

That competitive dynamic is not going away, come higher rates or no. You think all the Whartonites are going to become house painters or something?


The Great Divide
Deutsche Bank – July 15th 2016

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