While fees are still a big factor for investors choosing funds, there are plenty of other characteristics they are using to assess potential funds for their portfolio, according to a new report from fund tracker Morningstar.
One is longevity. Investors prefer long-running funds over newbies and are less influenced by recent performance than in the past, the firm said in its latest Quantitative Analytics Quarterly report, which examines what factors drive investment flows. What's more, performance isn't as big a factor as it used to be, the firm's analysts found.
For the report, Morningstar evaluated investor flows into U.S. open-end mutual funds, which does not include exchange-traded funds, between July 2003 and March 2018. Its first report on the subject looked at the time period between 2003 and 2015.
The difference in popularity between 5-star funds, Morningstar's highest rank, and 1-star funds, its lowest, wasn't as stark in the past three years as it was in the previous time period examined, Morningstar said.
"If Morningstar Ratings for funds (or star ratings) are an important driver of flows, then you would expect to see a large spread, because investors will buy 5-star funds and sell 1-star funds. However, in the past several years we have seen the spread decline, which indicates that part performance is having less impact on future flows," wrote the report's authors. "Investors tend to trade too much and have notoriously sold funds at the first sign of trouble. The lower spread may be a sign that investors are reacting less to recent performance."
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Morningstar found that over time, investors have primarily looked at the same factors when evaluating funds. The Chicago research firm, which looked at 26 characteristics that influence the buying decision, first reported on the reasons behind fund flows three years ago. Among the factors in Morningstar's study are net expense ratio, portfolio concentration, fund age, and turnover.
In addition, Morningstar found that investors punished weak performers more than they rewarded strong managers.
"Strongly performing funds still attract new investors, but to a smaller degree than in years past and poorly performing funds suffer more," the authors wrote. Investors may be learning from their past behavior, when they sold funds at precisely the wrong time, the authors stated.
Morningstar found that investors preferred funds with lower fees, fewer holdings, and that are offered by high-quality firms. Equity funds with fees that are higher than average, for example, experienced 0.49 percent lower growth than would otherwise be expected. With the growing popularity of index funds, investors have been gravitating to funds that hold fewer securities, which can equate to managers that are investing in only their best ideas, according to the report.