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December 4, 2017

Monday Morning Memo: Which Factors Drive Fund Flows in Europe?

by Detlef Glow.

Within the European fund industry calculation of fund flows is quite common, since market observers, fund associations, and even fund promoters publish and comment on these numbers to showcase the success of the fund industry and/or single products and to comment on current trends in Europe. But for fund promoters it is often a riddle as to why investors are buying a specific fund, given its performance. That said, a few companies—mainly consultants—look behind the scenes at the fund level to try to determine the main drivers of fund flows to help their clients gain inflows to their funds. With this blog I also try to shed light on possible drivers behind fund flows.

It’s not only about performance.

If the performance of a fund is the main driver for investors, net sales would be concentrated in the top three to five funds. In reality we witness net inflows even into funds with performance ranked in the third or fourth quartile. That said, the majority of measured net inflows can be seen going into funds with a first- or second-quartile performance. For me this showcases that performance—either absolute, relative, or risk-adjusted—is an important driver when it comes to investors’ buy-or-sell decisions, but obviously it is only one part of the puzzle.

Do investors care about costs?

With the ongoing discussions about fees and other costs in the European fund industry, one could conclude that the costs measured by the total expense ratio (TER) or the so-called ongoing charges are the main drivers in investors’ decision-making process. The rationale for this is quite clear: costs are a burden for a fund in trying to outperform its benchmark; therefore, a fund with lower fees and expenses should have a competitive advantage over its peers. In addition, lower costs are often quoted as a main reason investors buy ETFs, since these products have in most cases significantly lower costs compared to their actively managed peers. If all investors focused only on cost, all flows should go into funds with below-average cost. Obviously, this is not the case. Since the majority of investors seem to believe that a good active manager can outperform his benchmark, they are also willing to pay a premium for managers who have shown their ability to achieve superior returns. Nevertheless, European investors are rather cost conscious; they are not willing to pay just any price. In my conversations with institutional and semi-institutional investors I have learned that these investor groups do raise questions about fees, especially performance fees.  That happens even though they could access institutional share classes of the funds, which have lower fees than the retail share classes. From my point of view it can be said that fees and expenses do play a role in the fund-selection process of European investors, but they are also not the main driver in the fund selection process.

What drives fund sales?

I strongly believe that a combination of above-average performance with a moderate fee level will put funds on the quantitative shortlists of fund selectors. In addition, it is also important that a fund pass the qualitative measures of an investor to become part of a buy list. The depth of this due-diligence process varies from investor to investor, but two points often stated as knockout criteria by investors are the accessibility of information and the fund promoters’ service. Professional investors especially need access to fund information at all times, since they often want to look at funds outside the regular business hours of the fund promoters. Therefore, fund promoters have to maintain a webpage so these investors can instantly find all the information they need. In addition, investors want to have immediate answers to questions concerning current performance of the fund or specific market requirements.

From my point of view this means investors in Europe select funds that have proven they can deliver a value-added component compared to their market and the average of their peers and that have a moderate TER. In addition, fund promoters must be able to fulfill the different levels of service needed by investors. I would conclude that risk-adjusted performance can bring a fund to the short lists of fund selectors, but the decision to buy a fund is driven by the level of information and service offered by the fund promoter.

The views expressed are the views of the author, not necessarily those of Refinitiv.

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