Hybrid Mutual Funds and Other Trends for Investors to Follow

NEW YORK (MainStreet) — Hybrid funds, which invest in a mix of stocks and bonds, have been gaining in popularity over the past ten years, along with index funds and specialty exchange-traded funds or ETFs.

Here are some popular trends in mutual funds for investors to consider as they diversify assets and increased returns in their retirement portfolio.

Hybrid Mutual Funds Gain In Popularity

Aside from 2008, hybrid funds, which are also known as asset allocation or balanced funds, have seen “inflows every year in the past decade,” according to the Investment Company Institute, the Washington, D.C.-based national association of U.S. investment companies.

Many of these funds will allocate 65% of the assets in equities while the remaining 35% is in bonds, said Robert Johnson, CEO of The American College of Financial Services in Bryn Mawr, Pa. This strategy gives investors “a way to balance the potential capital appreciation of common stocks with the income and relative stability of bonds over the long term,” he said.

The rise of their popularity stems from the fact that they give investors an option on how to have a “managed, balanced portfolio” of stocks and bonds, Johnson said. During the last seven years, investors have added $384 billion in net new cash and reinvested dividends to these funds, he said. In 2013 alone, investors added a record $73 billion in net new cash flow to hybrid funds, up from $47 billion in 2012.

Index Funds Remain Attractive

Investors, of course, continue to turn to index funds as a simpler way to maximize their returns and are overwhelmingly popular. For consumers who invest in mutual funds, 30% purchased at least one index mutual fund in 2013, according to the Investment Company Institute. By the end of 2013, 372 index funds managed total net assets of $1.7 trillion and the demand for them kept increasing with investors adding $114 billion in net new cash flow to these funds.

Many people are drawn to domestic equity mutual funds, and demand for them more than tripled in 2014. Not surprisingly, many investors are still huge fans of S&P 500 index funds with 33% of all mutual fund assets invested in them. The largest mutual fund in the world is the Vanguard S&P 500 ETF with more than $206 billion in assets.

“Simply put, investors are increasingly embracing indexing and realizing that it is a prudent strategy for building wealth especially because they have much lower fees,” Johnson said. “Psychologically, some investors don't want to ‘settle’ for average returns, but after fees, it is very difficult for active funds to consistently outperform market index funds.”

A survey by S&P Dow Jones Indices, the New York-based index provider, said its survey released on June 4 found that approximately $7.8 trillion is now benchmarked to the iconic S&P 500 with $2.16 trillion of that figure directly indexed via ETFs, mutual funds and other investment product structures.

“The S&P 500 has clearly made its mark as the premier measure of U.S. stock market performance for investors throughout the world,” said Alex Matturri, CEO of S&P Dow Jones Indices. “Investor interest in index products based upon S&P DJI indices continues to grow.”

Fund Turnover Is Dipping

The average turnover rate or the percentage of a fund’s holdings that have changed during a year is a measure of a fund’s trading activity, said Johnson. In 2013, the annual turnover rate for equity fund investors was 41%, which is below the average of the past 34 years of 61%, Johnson said. One reason is that people are investing in index funds which have lower turnover rates than the average actively traded fund, he added.

Increased Focus on Specialty ETFs

The interest in specialty ETFs, both active and indexed, is not waning. Nowadays you can easily find an ETF that allows you to invest in “just about anything you want from small capitalization Brazilian stocks to firms headquartered in Oklahoma,” said Johnson. “You can even buy an ETF composed of the highest volatility stocks in the Russell 1000.”

While more specialty ETFs will continue to pop up, investors should be wary of many of them because the risk is larger.

“These specialty ETFs don’t represent very good investments for the vast majority of individual investors,” he said. “The real benefit from ETFs is that they allow an investor to gain exposure to a particular market such as the Brazilian or Australian market or a particular sector like natural resources or telecommunications and provide the individual with diversification within that sector.

The Rise of Liquid Alternatives Funds

Liquid alternatives or “liquid alts” are a relatively new type of mutual fund meant to mimic hedge fund strategies with leverage, derivatives and short-selling, said Johnson.

“In essence, they are bringing hedge fund investing to the masses,” he said. “These funds may engage in merger arbitrage, convertible arbitrage, long/short equity strategies, global macro strategies or a plethora of other investment strategies."

Assets under management in alternative mutual funds have grown at an annual pace of 38% since 2008, compared to just 13% for the hedge fund industry and 9% for the U.S. mutual fund industry as a whole, according to an October 2014 study from Deutsche Bank.

Most investors purchase these funds to diversify their portfolio and not “for their absolute return potential,” Johnson said. “The hope is that liquid alternatives provide portfolio stability and in essence that they will zig when the market zags.”

One caveat is that since they are actively managed funds, investors are facing much higher fees compared to other types of funds, he said. There are now 348 alternative mutual funds with $240 billion in assets, according to an April 2015 report from Prequin, a New York-based alternative assets data provider.

“This democratization of investment choices is especially evident in the growth of liquid alt funds,” said Bayard Closser, president of Vertical Capital Markets Group, an asset manager in Irvine, Calif. “Many believe that the Fed policy is creating an asset bubble and that stock prices could fall in 2015. That would increase demand for alternative assets that are not correlated with or that have a negative correlation with equities.”

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