The Markets February 27, 2014

Investment Fund Inflows Neared $1T in 2013

Investors around the world contributed almost $1 trillion in net flows to investment funds during 2013, similar to levels observed in the preceding year.
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The figure comes from fund research firm Strategic Insight (SI), an Asset International company, in its latest release of the State of the Global Fund Industry report. The research shows that, while the net flows into investment funds remained essentially level during 2013, the allocations changed dramatically in terms of the types of funds seeing the strongest interest.

Most notable, says Strategic Insight, is a shift away from traditional bond funds and into equity, multi-asset, non-traditional income, and alternative strategies.

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“Equity funds worldwide absorbed $610 billion of net inflows last year, slightly higher than the peaks in 2006 and 2007,” explains Jag Alexeyev, head of global research at Strategic Insight. “But other asset classes and themes also offered big opportunities for fund managers, especially outside the United States. Demand for non-traditional income, liquid alternatives, and asset allocation solutions expanded, and will continue to rise alongside the equity revival.”

When factoring in performance gains, worldwide assets under management grew to a total of $3 trillion. Funds in Europe, including cross-border products, played an important role and accounted for about half of worldwide flows, with a notable expansion among local European structures. 

Actively Managed Funds Absorb $600B – Mostly Outside the U.S.

Strategic Insight says mutual funds in the U.S. accounted for three-quarters of the global net flows to equity products last year. But more than 60% of that went to index funds and ETFs, the firm says. In contrast, outside the U.S., just one-quarter of equity flows went to passive strategies. 

Active fund managers outside the U.S. further benefited from substantial gains through non-traditional bond, mixed asset, and other long-term funds. Overall, actively-managed funds captured $570 billion of net inflows worldwide during 2013, of which three-quarters was generated outside of the U.S.

Funds in Europe and cross-border captured €320 billion ($425 billion) of net inflows during 2013, up 12% from the prior year, excluding money market vehicles. This was driven by local European funds, whose inflows doubled and surpassed €100 billion. Cross-border international funds based in Europe, which are also sold in other markets such as Asia and Latin America, gained €220 billion, or 8% less than in the year before.

Equity strategies captured 33% of inflows to European and cross-border funds during 2013, Strategic Insight says, compared to just 4% in the year before. Similarly, mixed asset funds attracted 31% of inflows, rising from 10%. 

Bond funds saw their share diminish, but still accounted for 30% or €100 billion of net gains. Much of this went to high yield, global unconstrained multi-sector bond, and flexible income strategies. Specialist segments such as convertible bond and senior loan funds also experienced growth, along with selected alternative credit strategies.

Strategic Insight says these factors should lead European investors to remember 2013 as one of the more balanced years on record, with roughly equal contributions to the two main asset classes and to multi-asset vehicles, providing opportunities for a broader range of firms.

Yet by the fourth quarter, equity funds’ share of net flows had risen to nearly 60%. “Progress during 2014 may be even more concentrated in equities if the global economy continues to recover and stock markets do not encounter any major setbacks,” Alexeyev says. “But the growth of asset allocation solutions, both through multi-asset vehicles or professionally advised diversification across specialist funds, and the persistent demand for income strategies should help prevent investments from getting too unbalanced as in the past.”

New Launches in Japan, and Multi-Asset Income and Equity in Hong Kong

Strategic Insight says a few segments in Asia also provided meaningful opportunities for local and international fund managers, notably in Japan, where flows grew by almost four times to reach $45 billion, primarily through new launches. In Hong Kong, retail gross sales of local and cross-border funds expanded by 30% to a record high, as a surge in multi-asset income products in the first half gave way to rising sales of equity strategies through the end of the year.

Bryan Liu, head of Asia research at Strategic Insight, says that total net new assets raised in Asia exceeded $60 billion in 2013. This sum was dragged down by China, he explains, where investors redeemed $25 billion, mostly from equity funds as the multi-year stagnation of region’s stock markets took its toll.

Continued Evolution of the Bond and Income Fund Business

The bond and income fund business continues to rapidly evolve as investors search for income alternatives that are less correlated with traditional long-only fixed income, and less vulnerable to losses during periods of rising interest rates.

Researchers say this has supported the expansion of unconstrained, flexible, absolute return, and other non-traditional bond and income funds. Such funds now account for 13% of bond fund assets in Europe and cross-border, rising from 8% during the past five years. 

The adoption of non-traditional income was even stronger than the gains experienced by the broader universe of alternatives, Strategic Insight says, whose share of long-term fund assets now approach 7%. Beyond bond funds, the demand for steady income has also sparked the growth of multi-asset income strategies, dividend equity, and funds that invest in other sources of income such as infrastructure and energy investments (including master limited partnerships). 

Non-Traditional Funds and Liquid Alternatives Grow in Importance

Non-traditional strategies, including absolute return and liquid alternatives, together captured more than $250 billion of net flows around the world during 2013. Strategic Insight says this will likely accelerate as investors further adjust allocations away from long-only bond risks and seek to limit exposure to stock market drawdowns.

The demand for non-correlated lower volatility alternatives is supporting innovation and growth in a variety of sectors, including hedge style strategies in mutual funds, hybrid absolute return, institutional diversified growth funds, risk-managed solutions, and smart beta alternative indexing approaches.

“The fund industry in five years will look very different,” says Alexeyev, “transformed not only by innovations in fund management and solutions, but also changes in regulation, investment advisory, and distribution models.”

More information on Strategic Insight and it’s latest research findings is available online at www.SIonline.com.

Compliance February 27, 2014

Industry Groups Alarmed About Tax Reform

A U.S. House leader has introduced a sweeping tax reform bill that has many in the retirement industry alarmed about its proposals concerning retirement plans.
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While the 979-page document introduced by U.S. House Ways and Means Committee Chairman Dave Camp (R-Michigan) does not include taxation of retirement contribution amounts and benefits caps President Obama suggested in earlier budget proposals, there are similar or new provisions industry groups say will result in double taxation and discouraging retirement plan benefit offerings.

Under current law, the limits on contributions to qualified retirement plans are indexed for inflation. The Camp proposal would freeze these increases in the contribution limits for 10 years. Therefore, individual elective deferrals to qualified retirement plans would be capped at $17,500 (or $23,000 for individuals eligible to make catch-up contributions) for the next decade. This provision would raise more than $63 billion in the next 10 years to pay for tax reform, according to an analysis by the Association of Pension Professionals & Actuaries’ (ASPPA) Congressional Affairs Manager Andrew Remo.

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The Camp proposal would subject all elective deferrals into qualified retirement plans above 50% of statutory limits ($8,750, or $11,500 for individuals eligible to make catch-up contributions) to Roth tax treatment—taxing them up front, rather than upon distribution. In addition, the proposal would require all employers with more than 100 employees to amend their plan documents to allow employees to make Roth contributions (if Roth contributions are not already permitted). Encouraging Roth savings accelerates the revenue flowing into government coffers in the short term, raising $143.7 billion over the next 10 years to pay for tax reform, Remo says.

Camp’s proposal would place a 25% cap on the rate at which deductions and exclusions (including those relating to retirement savings) reduce a taxpayer’s income tax liability. This is similar to a provision included in President Obama’s past budget proposals (see “Savings Cap Could Affect up to 5% of Participants”). Should this proposal become law, it would subject individuals in the new 35% tax bracket to a 10% surtax on all contributions made to a qualified retirement plan—that is, both employer and employee contributions. (Obama’s proposed cap did not apply to employer contributions.)

“The result of the 10% surtax is double taxation of plan contributions. It totally ignores the fact that these contributions are tax deferrals, not a permanent exclusion, and will be subject to ordinary income tax when they are withdrawn after retirement,” says Brian Graff, ASPPA’s executive director and CEO, in a statement. “Should this proposal become law, a small business owner could pay a 10% surtax on all contributions made to a qualified retirement plan today, then pay tax again at the full ordinary income tax rate when they retire.”

Graff adds: “Penalizing small business owners for contributing to a plan is going to make them think twice about sponsoring a plan at all, and their employees could lose their workplace retirement plan as a result. Double taxation is hardly what we hoped to see in any tax reform proposal.”

Graff also expresses concern about the impact of the proposed freeze on contribution limits until 2023. “After all, the cost of living in retirement is not going to be frozen,” he points out. “On top of the double taxation mistake, this is a real blow to employer-sponsored retirement plans, and to American workers’ retirement security.”

Graff says ASPPA is very disappointed to see these provisions, and would have accepted the proposal if the reduction to retirement savings tax incentives was limited to requiring 401(k) contributions above 50% of the contribution limit to be Roth only. “Unfortunately, that is not the case, and we must strongly oppose this tax reform proposal given its negative impact on American workers’ retirement security,” he concludes.

The Plan Sponsor Council of America (PSCA) also issued a statement saying several provisions in Chairman Camp’s proposal will diminish the retirement savings opportunities for working Americans. “The requirement that employee contributions above a certain amount to a 401(k) or similar plan be made on a Roth basis will add complexity and increase administrative costs,” the council notes. 

In addition, it expresses concern that rules that limit top earners’, often small business owners, ability to claim a full deferral for contributions made to their savings account will reduce the willingness to offer a plan to their employees, and the repeal of the small employer pension plan startup credit removes a valuable incentive to owners considering establishing a plan for their workers. 

“Additionally, eliminating inflation adjustments for contribution limits for ten years provides another reason for a business owner to decide against offering a plan. Many workers will also be affected by the limit freezes,” ASPPA continues.

The Camp tax reform proposal also makes changes in other areas, according to Remo’s analysis, including elimination of new Simplified Employee Pensions (SEPs) and Savings Incentive Match Plan for Employees (SIMPLE) 401(k) plans going forward—existing SEPS and SIMPLE 401(k)s could continue to exist, modification of retirement plan distribution rules, and changes in the rules governing individual retirement accounts (IRAs) to encourage Roth savings and combat leakage.

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