Who pulled back on equities and lowering fees? What factors dominated and were impacted the most by interest rates? How did regime and climate change impact fund performance?
Investment Metrics recently hosted a webinar featuring our research on Q3 fees, factors and asset flows. We observed allocation movement, gross and net flows, factor trends, and the impact from interest rates within style using calculated flows from the Investment Metrics Global Database, Plan Universe, Manager Research post-negotiated fees, and Factor Analysis which processes data from live portfolios.
Here are the highlights on the big fund moves, impacts and drivers based on our research analysis.
Pull back from equity to alternatives and fixed income
Looking across equity, fixed income, and alternative investment allocations, Q3 saw a major pull back from publicly traded equity for all plan types with the exception of Taft-Hartley. There were more allocations in fixed income, publics, endowments and foundations, and some movement into alternatives favoring private equity.
De-risking occurred as corporate plans continue to shift into fixed income. Particularly, flows were moving out of US fixed income, yet virtually no allocations pulled back from global and emerging markets. Similarly on the equity side, US equity flows have stabilized or pulled back to the point where 2021 outflows will be less than those in 2020. However, non-US equity (international, global and emerging markets) pulled back slightly positioning 2021 outflows to be on pace to exceed 2020.
Growth dominates on US large cap, Value on US small cap
When analyzing gross asset gains – managers’ actual reported assets gained, broken down by style, Core, Growth and Value – we saw Growth dominate US equity, particularly active Large Cap US equity. In US Small Cap, Core lagged while Value dominated with $17 billion in assets gained.
Continued fee premium and compression
Using our Fee Analyzer, which analyzes actual post negotiated fees for all institutional plans, we looked at the Large Cap universe across all time periods as well as all plan and consultant sizes. Overall, fees have come down by about 2% since September of 2018.
By style, US Large Cap Growth continued in Q3 with a fee premium of about 50 basis points, representing the lion’s share of assets gained. In terms of percentages, we saw the largest decrease in fees of about 7%. Although there was clearly still a premium to Value, it came down more rapidly than Value and Core where the decrease ranged from 1% to about 3%.
Performing the same analysis for active US Small Cap fees, similarly, we saw premiums align with those of US Large Cap with an average of 25 basis points higher to the median level. Growth charged a premium, where the median Growth on the high end is about 80 basis points. The difference, however, was on the Value side where fees came down more rapidly than other mandates.
In summary, our data on flows and fees indicated that Growth and Large Cap dominated on the passive side, while Small Cap was more competitive on the active side.
Value and Growth performance follow interest rates
Over the long term, we have observed a strong relationship between the Value / Growth performance spread and the 10-year interest rate movements. For every 10% increase in the US long rate, Value outperforms Growth by about a 1% spread in the US and about 0.5% in the UK. In Q3, we saw a consistent behavior, with Value beating Growth only in those months with significant long-term interest rate increases.
Factors’ Book-to-Price performance in Q3
In July, high US Book-to-Price stocks underperformed the broad market by about 80 basis points. All the Value subfactors underperformed the market in August, but outperformed in September. Congruent with the long-rate relationship pattern, we saw Value stocks outperforming Growth. Growth had the opposite story.
Continuing with past trends, Growth and Quality have been strongly correlated. Large Cap did well when Growth and Quality did well, but underperformed when Value excelled. High Volatility stocks followed a similar track; they only did well in September when Value underperformed.
Momentum has a different story. In 2020, Momentum was synonymous with Growth. Once Value rallied in 2021, Momentum started to become synonymous with Value once it outperformed. In the last several months, Momentum has become more synonymous with Quality as it solidly outperformed almost every month.
In Q3, the factor story in the US and Europe were nearly identical, which is not common. Inflationary pressure was likely having an impact on how the relative Value and Growth stocks perform.
Q4 factor preview – a snapshot of October
In the US, interest rates remained relatively flat in October, reverting back to the classic scenario of Value down, Growth and Quality up, and Momentum following. Remarkably, Europe had a very similar story. Only in September where we saw the rate increasing did we also see a Value outperformance.
Regime and climate change patterns
Other research in Q3 showed factor performance patterns driven by regime changes. During past historical events, we found that Quality stocks outperformed high Volatility stocks, and Small Caps underperformed. Hence, Quality, low Volatility and Large Cap stocks tend to be safe bets during times of geopolitical turmoil.
In looking at the factor profiles of the top seven European climate funds, we found that while all the funds provide high and improving ESG scores, each provides different fundamental factor exposure ranging from deep Value to anti-Value, and a broad range of Growth and Quality exposures.
Also, Growth and Quality were not necessarily combined in these Climate Funds. It is possible to have Value-Quality funds and Growth-Quality funds, all while simultaneously existing as climate funds. However, almost all climate funds bet on high Volatility stocks. The need to truly understand the factor exposures and style tilts in climate funds is clear.
See the Investment Metrics difference
This research is done by Investment Metrics, a leading global provider of investment analytics, reporting, data, and research solutions that help institutional investors and advisors achieve better financial outcomes with clear investment insights. With over 400 clients across 30 countries, our solutions drive insights across 20K+ institutional asset pools, 28K+ funds, and 910K+ portfolios representing $14T+ in AUA. To learn more about this topic, please watch our webinar on Q3 Fees, Factors & Flows.
The material presented in this document is an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any funds or any issuer or security or similar.
This document contains general information only, does not consider an individual’s financial circumstances and should not be relied upon for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should always be given to consult a Financial Advisor before making an investment decision.
Investment Metrics, a Confluence company, does not provide investment advice and nothing in this document should be considered any form of advice. Investment Metrics accepts no liability whatsoever for any information provided or inferred in this document.