Follow the Money


New York – Equity assets in US mutual funds illustrate the story of the equity research industry, and the picture doesn’t look very pretty.  The outlook is not encouraging as investors remain wary of stocks.

Assets in US equity mutual funds peaked in 2007 at $6.5 trillion before collapsing 43% to $3.7 trillion in 2008.  Research firms paid in commissions, including the ‘proprietary research’ offered by large broker dealers, did not feel the full effect of the asset decline because extreme volatility kept commissions high.  The canaries in the coal mine were independent research firms in paid cash, which got slammed in 2008 as asset managers cut back direct expenses to offset management fees reduced by declining assets.

Equity assets bounced 34% in 2009 to nearly $5 trillion, but research firms paid in commissions began to feel the pain as volatility dropped and commissions began to reflect the lower asset levels, which were still 24% below the peak.   Research firms paid in cash experienced an uptick in 2009, reflecting the improved asset levels, and attendant revenue increases.

All is not well, however, as equity asset levels remain depressed.  Equity funds generate higher management fees than bond funds or money funds, which have modestly increased in assets since 2007.  (Bond funds increased to $2.2 trillion in 2009 from $1.7 trillion in 2007 and money funds increased to $3.3 trillion in 2009 from $3.1 trillion in 2007.)

Assets are generated by market appreciation, which was the case in 2009, and by capital inflows, as investors invest money in funds.  Fund industry statistics show that the asset flows into equities are non-existent.

In 2003, equity market performance rebounded from the crash, and asset flows into equity funds quickly followed suit, as the chart above, sourced from the Investment Company Institute 2010 Investment Company Fact Book,  illustrates.  What is striking about the chart is how anemic equity asset flows are now, despite the dramatic recovery in market performance.  Equity returns rebounded dramatically and yet asset flows have not followed.

This does not bode well for equities or equity research.  It suggests a long-term impact from the financial crisis, reminiscent of the impact of the great depression which left a generation distrustful of markets.   Even if memories were shortening, the flash crash and the European credit crisis provided fresh reinforcement.

Mutual fund assets don’t tell the whole story.  Hedge fund assets have rebounded sharply, and not just from market appreciation, as pension funds seek absolute returns to ease underfunded liabilities.  Nevertheless, lagging mutual fund assets represent on ongoing drag on the research industry, one that is not likely to rebound quickly.


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