Vanguard’s latest market risk Speedometer suggests that advisors took a risk-off approach to allocation in the past six to 12 months despite the S&P 500 being on the cusp of a bull market this year.
Fran Kinniry thinks that’s a prudent play.
Kinniry, the head of Vanguard’s Investment Advisory Research Center, recently spoke with VettaFi contributor Dan Mika. They discussed the shift in recent fund flow trends that suggests rebalancing, not performance-chasing, is the trend.
The following interview has been edited for clarity and brevity.
Dan Mika: Can you explain this hypothesized shift to top-down investing that this report mentions, especially compared to recent years, and why that’s considered a positive development?
Fran Kinniry: What we have seen in cash flows through most of history is something known as trend-following or momentum, there’s different terms for it. It’s pretty well evidenced, if you look at cash flows throughout most of history, of following performance.
I think one of the key potential mistakes is that when others look at cash flow, they don’t look at what’s happening in the markets. They also don’t look at what’s happening in asset allocation. You can’t just comment on cash flow. I saw quite a few well-known places — I won’t name them — saying that investors missed this bull market of 2023. But that’s not true when you look at asset allocation near peak equity.
What we’ve been seeing [during] the last five to 10 years is cash flow looking more institutional, meaning that you have an asset allocation and you rebalance to your policy portfolio. That’s great behavior, versus what we saw [in] the prior 20 or 30 years.
A Move Into Non-U.S. Equities
Dan Mika: What is leading to this rebalancing into non-U.S. equities versus U.S. equities? I’m reminded of a recent Morningstar report that dives into some of the structural reasons of why U.S. stocks were not just outperforming the rest of the world, but for maintaining very close volatility to a global index. What’s leading a rebalance to ex-U.S. stocks?
Fran Kinniry: I’m looking at the performance that we put out there… the U.S. has outperformed non-U.S. pretty dramatically over all time periods: six months, 12 months, five years, and 10 years. Prudent cash flow would be more into non-U.S., and that’s what we’re seeing. 20 years ago, you would have seen investors bail on non-U.S. investments and put all their assets in the U.S. So again, a very positive trend.
Dan Mika: We’re looking at the broader economy and seeing a narrative turn that consumers and the economy can stomach a 5% interest rate by the Federal Reserve, that a recession is not a foregone conclusion in the coming years. Does that affect any of the risk tolerance or kinds of rebalancing strategies that advisors may have consider for their clients?
Fran Kinniry: We’re not really good at forecasting what the cash flow is going to be. What I would say is that it’s going to really depend on what happens to the performance. We don’t know yet what the relative performance of U.S. stocks to non-U.S. stocks is, or U.S. stocks to bonds, or equities to bonds, and bonds to the money markets. We will see how that all plays out.
Interest in Money Markets Rebounds
Money markets were yielding at 0% or somewhere just a little above 0% since the Global Financial Crisis. That’s 15 years where you could say money markets were having a very, very low yield. Money markets now have a more “normal” yield, if that’s the right word, 4.5% to 5.25%. You can see why there’s been interest, heavy interest, in money markets over the last six to 12 months.
Dan Mika: This report cites a consistent outflow from active mutual funds among equity funds, particularly in U.S. equities, during all these time periods. At the same time, there’s steady increases in ETF allocations. What does that tell you about how investors are thinking about the wrapper they prefer for their equity allocation?
Fran Kinniry: Not only is this more of the institutional rebalancing trend, but there has been a real preference for ETFs over mutual funds… There’s been a strong preference toward exchange traded funds over mutual funds, index or active. I think that the ETF was an incredible innovation. For us, we always thought it was about, how do you have better distribution of world-class indexing? Before you would have to come to Vanguard to get best-in-class indexing, and traded Vanguard [strategies] through a mutual fund. Now you can buy an ETF straight, just like a stock. You can trade it anywhere and still be assured you’re getting best-in-class indexing, which is Vanguard, and managing it through an ETF wrapper.
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