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Investors face new choices going into 2016 as global monetary policy reaches another fork in the road


Mutual fund investors rode into 2015 on a wave of relief that the US Federal Reserve had not hiked interest rates. They ended it digesting the first increase in US rates since 2Q06, a hike that sets US monetary policy at variance with that of Japan and much of Europe.

In between, they spent the year pursuing the two major quantitative easing (QE) stories in Japan and Europe, fretting about the state of China's economy and positioning themselves for action by the Fed.
The upshot of this QE bias was record setting inflows for Europe, Japan and Global ex-US Equity Funds and record setting outflows for US, Emerging Markets and China Equity Funds and Emerging Markets Bond Funds. Preliminary figures based on monthly and daily data also show Europe Money Market and Europe High Yield Bond Funds set new inflow marks.
Viewed in isolation, 4Q15 was marked by significant elections in Spain, Argentina, Venezuela and Burma, major terrorist attacks in France and Egypt, further declines in energy and commodities prices and renewed fears of a currency war in Asia. The last three months of 2015 also saw ratings downgrades for Brazil and South Africa that took those countries perilously close to 'junk' status at a time when EPFR Global-tracked High Yield Bonds were – for the ninth time in the past 18 months – seeing outflows surge.
Passively managed Equity Funds outperformed their actively managed counterparts overall during 4Q15, with ETF outperformance most pronounced among US and Asia ex-Japan Equity Funds while actively managed Europe, Japan and Global Emerging Markets (GEM) Equity Funds did better than their ETF peers. On the fixed income side actively managed Bond Funds generally outperformed ETFs, especially among US and Asia Pacific Bond Funds.
Retail investors bailed out of almost every fund group between October and December. Only Municipal Bond Funds retained their affection, although retail flows into Europe Equity and Money Market Funds did pick up in the final weeks of 2015.
At the country level both Thailand Equity and Bond Funds attracted strong inflows thanks to the country's role in Japan's corporate supply chain, the lack of political drama and local investors moving out of previously guaranteed bank accounts, Canada Equity Funds recorded their biggest quarterly inflow since 1Q11 and Brazil Bond Funds were on track for their largest quarterly outflow on record.
EPFR Global-tracked Emerging Markets Equity Funds carried a nine week outflow streak onto the New Year as weaker commodities prices, ratings downgrades in key markets, questions about the true state of China's economy and the anticipation of higher US interest rates chilled investor sentiment. For flows, the anticipation of the US Federal Reserve's decision to raise its key interest by 0.25% in mid-December was worse than the reality, with redemptions from this fund group moderating during the final two weeks of 2016.
A degree of resolution on US interest rates was, however, quickly overshadowed by fresh uncertainty about China's economic performance and renewed fears that Chinese policymakers may embrace competitive devaluation to bolster its manufacturing and export sectors. Once again Asia ex-Japan Equity Funds were the hardest hit among the major regional groups by investor redemptions on their way to posting a new full-year record for outflows. In the case of several Country Fund groups local currency flows had the greatest bearing on the headline number. This was true of China, Thailand and Korea Equity Funds , with the latter seeing won and foreign currency denominated flows move in opposite directions for much of the year.
China's slowing economy and volatile stock market were broadly discounted by the managers of the big, diversified fund groups. Going into the final weeks of 2015 the average GEM and Asia ex-Japan Equity Fund allocation for China was close to the record highs set in late 2Q15. GEM Equity Fund managers were not so forgiving of Brazil's stalled economic growth, political turmoil and high inflation. Allocations for that market ended the year testing record lows despite a revival of investor interest tied to the electoral rebukes issued to left-of-centre governments by voters in Argentina and Venezuela.
EMEA Equity Funds struggled through the final quarter of 2015 as the deteriorating political and economic outlooks for South Africa, Nigeria, Turkey and – to a lesser extent – Poland offset a thaw in sentiment towards Russia. Africa's dependence on Chinese capital and demand for raw materials, the impact of slumping oil prices on the Nigerian and Angolan and economies and South Africa's ratings downgrade saw redemptions from Africa Regional and South Africa Equity Funds hit 30 and a 49 week highs respectively during the fourth quarter.
The direction of monetary policy continued to guide flows into and out of EPFR Global-tracked Developed Markets Equity Funds during the final months of 2015. US Equity Funds experienced further outflows, as did Global Equity Funds, while Europe, Japan and Global ex-US Equity Funds added to their record setting inflow totals.
With the first interest rate hike in over nine years adding to the pressure a strong dollar was putting on US corporate earnings the money kept flowing out of US Equity Funds. Retail investors, who have now redeemed money from this fund group 49 of the past 52 weeks, led the exodus.
US Equity Fund managers allocating money by industry consistently gave software companies the biggest weighting in their portfolios, followed by pharmaceutical plays, retailers and technology hardware companies. The biggest risers in 2015 were banks. At the start of the year they were the 10th biggest single industry allocation among US Equity Funds; by the end they had risen to seventh.
Europe Equity Funds  received a boost during December when the European Central Bank extended the duration of its current QE program and cut its discount rate again. Although markets reacted with disappointment, mutual fund investors saw the moves as pro-cyclical at a time when the Eurozone is recovering thanks to lower energy costs and the abandonment of fiscal targets in the face of Europe's immigration and security challenges. At the country level investors earlier enthusiasm for Italy's reform story has waned, with Italy Equity Funds recording outflows four of the year's final six weeks and starting 2016 with their biggest weekly outflow since 4Q14.
Domestic institutional investors kept Japan Equity Fund flows in positive territory during a quarter when foreign currency flows were again generally flat. Although Japan escaped recession in the third quarter investors are looking for the Bank of Japan to step up its QE program and wondering just how much appetite for structural reform Shinzo Abe's government will have in an election year.
Overall flows into Global Equity Funds, the largest of the diversified Developed Markets Equity Fund groups, smashed the full year inflow record they set in 2013. But it was very much a tale of two sub-groups, with Global ex-US Equity Funds taking in over USD140 billion during the year while their fully global counterparts experienced their biggest outflow since 2012.
Higher US interest rates, and their effect on consumer demand, dollar strength and corporate profits, shaped flows for most EPFR Global-tracked Sector Fund groups during 4Q15. After rebounding in October following the Fed's decision not to raise rates in September, flows to Technology, Consumer Goods, Energy, Real Estate and Financial Sector Funds stalled or rolled over.
Energy Sector Funds reflected perhaps the biggest contrarian bet made by mutual fund investors in 2015. Despite turning in by far the worst performance numbers among the 11 major groups tracked by EPFR Global they recorded the second largest inflow as investors positioned themselves for a rebound in oil prices – which has still not materialised – and the profits that will bring to restructured energy majors. The share of overall flows attributable to Master Limited Partnership (MLP) Funds , which invest in US-based 'mid-stream' assets such as storage farms and pipelines, fell to its lowest level since 2009.
The biggest money magnets for the year, Healthcare/Biotechnology Sector Funds , posted inflows 28 of the 39 weeks through the end of the third quarter but saw money flow out nine of the fourth quarter's 13 weeks as political attacks on high drug prices and expensive valuations prompted investors to pull back from Biotechnology Funds.
Utilities and Infrastructure Sector Funds vied for the title of least loved Sector Fund group throughout 2015 with the race going down to the wire. Infrastructure Sector Funds, which have felt the chill from reduced capital spending by mining and energy companies, have not recorded inflows since the final week of 1Q15.
Uncertainty about the impact of higher US interest rates on riskier fixed income classes saw EPFR Global-tracked Bond Funds end 2015 by posting back-to-back quarterly outflows for the first time since 4Q13. Funds dedicated to mortgage backed securities, European junk bonds, municipal debt and inflation protected bonds were among the few to take in fresh money during the final three months of 2015.
Among the groups hit hardest by the prospect of even tighter US monetary policy were Balanced, Emerging Markets, Bank Loan, Total Return and Convertible Bond Funds. The two major multi-asset fund groups, Balanced and Total Return Bond Funds, remained under a cloud thanks to concerns about market liquidity. Total Return Funds, which saw a 69 week inflow streak end in early 2Q15, ended 2016 having posted outflows 23 of the past 26 weeks while over USD7 billion flowed out of Balanced Funds in December alone.
Emerging Markets Bond Funds also endured steady outflows as ratings downgrades for Brazil and South Africa exacerbated the concerns stemming from higher US interest rates. The headline number would have been worse but for the robust domestic flows enjoyed by Thailand Bond Funds. Going into the final weeks of the year managers of the diversified GEM Bond Funds were rotating exposure from South Africa, Turkey and Brazil to Russia and Poland.
Flows to Europe Bond Funds stumbled during the quarter, with this fund group posting outflows nine of the 13 weeks, as investors struggled to find bonds offering any kind of yield at a reasonable price. At the asset class level Europe High Yield, Inflation Protected and Total Return Bond Funds chalked up modest inflows while, at the country level, only Sweden and Denmark Bond Funds attracted over USD100 million during the quarter.
Among the US Bond Fund groups Mortgage Backed Bond Funds continue to pull in new money. Intermediate Term, Long Term Corporate and Municipal Bond Funds also recorded solid inflows in 4Q15 that were not enough to offset redemptions from Short Term, Total Return, High Yield and Bank Loan Bond Funds.

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