Morningstar Advisor - October/November 2013 - (Page 36)
Fund Distribution Has Been Turned
on Its Head. Now What?
By Scott Burns
Advisors struggle to define their role in the new model.
In the summer of 2011, something puzzling was
happening. American Funds Growth Fund
of America AGTHX, a 5-star fund, was
experiencing staggering outflows of about
$3 billion a month. Meanwhile, 3-star
exchange-traded funds that tracked large-cap
indexes were attracting strong inflows.
Granted, Growth Fund of America has
subsequently seen its Morningstar rating drop
to 3 stars, but at the time, we were witnessing
an unprecedented set of investor behavior.
Investors were tossing well-established,
historically high-performing strategies for, by
definition, average-performing index funds.
Here at Morningstar, we started digging into
why is this was happening. My article “Turning
Fund Distribution on its Head,” which ran
in the August/September 2011 issue, was the
culmination of some of this research.
The simplest solution tends to be the answer in
finance. In this case, the simplest answer—
and one espoused by indexing diehards—was
that investors had simply tired of paying
a premium for active management only to get
subpar performance. In that answer, index
and exchange-traded funds became
the logical beneficiaries of outflows from
We ultimately rejected that theory as the
driving force of the sea-change in flows that
36 Morningstar Advisor October/November 2013
we were witnessing. That theory might explain
why poor or mediocre funds would experience
outflows, but it did nothing to explain why
active funds that were outperforming indexes
were experiencing severe outflows. To explain
that, we needed to look at factors driving
investor preference beyond what returns and
finance papers could explain.
In the end, we proposed that there were two
primary drivers causing this shift in flows
between vehicles and from active to passive.
The first was a switch in advisor-incentive
systems from a commission-based model to an
assets-under-advisement fee-based model.
The second was the launching of new
investment technologies, primarily ETFs.
That was our view in 2011. Two years later, how
accurate was our hypothesis? Overall, I would
say I am happy with the effectiveness of
the framework that we presented. I would put
the results of the predictions into three
camps: spot on; right church, but wrong pew;
and a swing and a miss.
The Spot-On Predictions
The prediction that had the most uncertainty
associated with it at the time turned out
to be our most spot-on call. In the summer
of 2011, PIMCO was preparing to launch
an active-ETF version of its phenomenally
successful open-end fund PIMCO Total Return
PTTAX. We predicted that BOND would be
a success. Boy, has it ever been.
Launching out of the gate with a large initial
seeding, the fund raced to having billions
in assets within several months of its launch
in early 2012. BOND trails only the ubiquitous
PowerShares QQQ QQQ in the history ledger
in terms of being the fastest-growing ETF of all
time. That is, not just the fastest-growing
active ETF, but the fastest-growing ETF, period.
In addition to stellar asset gathering, BOND
also outperformed not only the benchmark, but
also the cheaper institutional shares of its
sister mutual fund by hundreds of basis points.
All and all, it was quite a successful launch.
Also in the spot-on camp is our prediction that
fee-based advisor schemes would continue to
overtake commission programs. While it
is difficult for us to get our hands on accurate
data on this front, I don’t think there is
anyone out there who would question that the
switch to fee-based advice is happening across
the board. Most likely there will remain some
small amount of commission-based advice
where it makes sense. But it is becoming pretty
clear that when new clients come in the
door, advisors whether captive or independent
are likely to provide them with a fee-based
program. We think conversion of existing
clients to fee-based programs is beginning to
accelerate as well.
Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2013
Morningstar Advisor - October/November 2013
Letter From the Editor
How to Make Social Media Work for You
Do Mutual Funds Still Have a Role?
More Personal Than Finance
How to Handle Your TIPS Positions
A Real Estate Veteran Starts From Scratch
Investments á la Carte
When to Say No
Take a Guarded Approach to Homebuilders
Fund Distribution Has Been Turned on Its Head. Now What?
Winning the Distribution Battle
Active ETFs Wait for Their Heyday
A Fund Firm Defies Indexing Trend
Piloting New Channels
A Good Fit
The Predictive Power of Fair Value Estimates
Does Being Prudent Pay Off?
Utilizing Utilities’ Total Return
Stuck in the Middle Is Not a Bad Place to Be
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Good Guys Win
Morningstar Advisor - October/November 2013