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Inflation fears let air out of some equity fund flows

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Inflation, the ongoing Eurozone debt crisis, capital controls, the start of the fourth quarter earnings season and a stronger US dollar were among the factors driving markets during the second week of January.

Flows into EPFR-tracked funds slowed appreciably as investors tried to make sense of these issues, with equity funds absorbing USD5.4 billion compared to USD9.2 billion the previous week and bond funds taking in just shy of USD2 billion.

Fears that the sovereign debt woes which started with Greece during 1H10 have yet to be contained weighed on Europe Equity and Europe Bond Funds and exerted a drag on some emerging markets, including China, that send a large share of their exports to the EU bloc. China is also one of the markets whose response to food-driven inflationary pressures is clouding the outlook for economic growth.

The US dollar’s rebound, meanwhile, helped Japan Equity Funds extend their latest inflow streak and gave Technology Sector Funds a boost. But Commodity Sector Funds posted outflows for the first time since early November. Fund flows sent mixed signals when it came to investors‚ risk appetite. High Yield Bond and Russia Equity Funds enjoyed another good week while flows into Frontier Equity Funds lost some momentum and Money Market Funds posted modest inflows.

Worries that high inflation rates in many of the major emerging markets, including all four of the BRIC (Brazil, Russia, India and China) countries, will trigger additional tightening and capital control measures cooled flows into EPFR Global-tracked Emerging Markets Equity Funds during the week ending January 12. Although the diversified Global Emerging Markets (GEM) Equity Funds extended their current inflow streak to eight straight weeks, the amount they took in was around a third of their weekly average for 2010, and dedicated BRIC Equity Funds had their worst week since late 3Q08.

All three of the other major emerging markets fund groups posted inflows in the USD300 million to USD600 million range, with EMEA Equity Funds standing out as they posted their highest weekly tally since late April as investors responded to Russia ‚s cheap valuations and strong energy story. This fund group has now taken in fresh money for 18 consecutive weeks. Interest from retail investors appears, however, to have peaked with the trend line pointing down since late October.

Flows into Asia ex-Japan Equity Funds were again shaped by caution regarding China , where food and property inflation remain serious policy challenges, and enthusiasm for markets that were heavily sold at times during the second half of last year. Korea Equity Funds enjoyed another solid week of inflows and Taiwan Equity Funds posted their biggest weekly tally since mid-July.

Brazil was again the driver for Latin America Equity Funds, despite some aggressive talk from key policymakers about „currency wars,‰ while investors continue to bail out of Mexico Equity Funds that historically benefit from optimistic assessments of US prospects.

EPFR Global-tracked Developed Markets Equity Funds continue to outpace their emerging markets counterparts when it comes to attracting fresh money. The week ending January 12 was the fifth out of the past six that they posted higher inflows; between the start of June and the end of November 2010 Emerging Markets Equity Funds came out on top 19 of the 26 weeks during than span.

US Equity Funds again saw the biggest inflows in dollar terms, although the weekly trend as been on a downward path since mid-December. Flows were more evenly distributed across capitalizations and styles than has been the case in recent months, with Large Cap and Small Cap Funds attracting nearly equal amounts of money. In another departure from recent trends, two-thirds of the net inflows went to actively managed funds.

Enthusiasm for US prospects, and the stronger dollar that goes with it, helped Japan Equity Funds extend their current inflow streak to seven consecutive weeks, their longest since a 14 week run ended in late March. A stronger US  currency is supportive for the country’s key export sector.

Eurozone exporters are also enjoying a more competitive currency versus the dollar, something which has boosted the already decent outlook for Germany . But fiscal concerns and Switzerland‚s deteriorating export story as its currency climbs versus the euro, offset a 16th straight week of flows into Germany Equity Funds.

Both of the major diversified developed markets fund groups took in fresh money. Flows into Pacific Equity Funds hit a 12-week high while Global Equity Funds absorbed around a quarter of the previous week‚s eye-catching total.

EPFR Global-tracked Commodity Sector Funds saw their nine week inflow streak end during the second week of January as the US dollar appreciated. But the stronger US  currency — and the predictions of better than expected economic growth that underlie the recent appreciation — helped Technology Sector Funds post their biggest weekly inflow since early 3Q09.

The prospect of US consumers armed with a stronger currency and some positive 4Q10 earnings reports did not translate into strong inflows for Consumer Goods Sector Funds. Redemptions hit a 27 week high, possibly due to covering of short positions taken through ETFs. Real Estate Sector Funds did, however, have their best week since early November and Financial Sector Funds managed to attract fresh money for the fifth time in the past six weeks.

Funds investing in the more defensive sectors had a better than expected week as Healthcare/Biotechnology Sector Funds, Utilities and Telecom Sector Funds all recorded modest inflows.

Two weeks into the young year Technology and Commodities Sector Funds are the clear leaders when it comes to attracting new money, as they were during the same period last year, while Energy and Consumer Goods Sector Funds have taken the brunt of the year-to-date redemptions.

Concerns about US municipal and Eurozone sovereign debt continued to hobble EPFR Global-tracked bond funds during the week ending January 12, with Europe Bond Funds posting outflows for a 13th consecutive week and US Bond Funds extending their worst run since 4Q08. But, in other areas, investors showed signs of returning risk appetite with Emerging Markets Local Currency and High Yield Bond Funds enjoying solid weeks.

Declining default rates, stronger US  economic growth and a general hunger for yield have boosted demand for high yield debt in recent weeks. On the heels of last week‚s record setting inflow, High Yield Bond Funds absorbed another USD1.2 billion. Since the middle of last year these funds have pulled in over USD25 billion.

Emerging Markets Bond Funds saw inflows climb to a nine week high. Funds with local currency mandates accounted for two-thirds of those inflows as the spread between US Treasuries and JP Morgan‚s benchmark EMBI+ index fell towards the 230 basis points level.  

Among the major US Bond Fund sub-groups, Municipal Bond Funds suffered their fifth straight week of $1 billion plus redemptions. Some of this exposure is being rotated to Floating Rate Funds which are currently sitting on a 27 week, USD8.5 billion inflow streak.

Global Bond Funds, which are coming off a record-setting year, posted another week of solid inflows that are well below their weekly average for 2010.

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