Investors return to equity funds – green shoots or end-of-tax-year blip?

The UK fund market saw inflows of £446 million in March, as investors tentatively returned after withdrawing £2.7 billion in February. That’s according to the latest data from the Investment Association (IA).

Fixed income funds saw the biggest inflows (£809 million), followed by equities (£149 million). This is the first time equities have been positive since December 2021. All other asset classes were in outflows.

While it is still early days, the latest data could suggest investor confidence is improving, as interest rate cuts loom on the horizon. Equities tend to perform well when interest rates fall, as lower rates typically boost the economy and earnings, resulting in stronger company performance.

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However, as AJ Bell’s head of investment analysis, Laith Khalaf, points out, it could simply be a case of increased activity at the end of the tax year. Last minute ISA investors create a flurry of investment activity each year in March, as they frantically maximise their £20,000 allowance before 5 April. 

We take a closer look at the data, before assessing how markets could evolve going forward. 

Which asset classes proved most popular with investors?

While money market funds were the most popular asset class with investors at the start of the year in January, they saw big outflows in February and more modest outflows in March. 

It is still early days, but this could point to an increased level of investor confidence as investors switch into equities and longer-duration fixed income instead. 

Source: Investment Association 

This pattern would make sense when you consider the broader economic environment. The rate of inflation has been slowing, and it is only a matter of time before central banks start cutting rates – even if expectations have been pushed out by a couple of months.

Equities tend to outperform other asset classes when interest rates are cut. Meanwhile, longer-duration bonds start to look more attractive than cash or money market instruments at this stage of the economic cycle, thanks to their ability to lock in higher interest rates for longer. 

“Fund managers will be hoping this is the start of some green shoots of recovery for the industry”, says Khalaf, however they will have to wait and see whether the modest equity inflows in March develop into more of a sustained pattern.

Which regions did equity investors favour?

From a regional perspective, global equities led the charge in March (+£753 million), with US equities trailing closely behind (+£654 million). However, US equity funds proved most popular in the first quarter overall (and by some margin), with net inflows of £1.5 billion.  

Source: Investment Association 

US equities have seen strong growth in recent years, partly driven by the stratospheric rise of the Magnificent Seven tech stocks. However, investors should keep an eye on some potential headwinds going forward. 

US GDP growth came in at 1.6% for the first quarter of the year, disappointing consensus estimates of 2.5%. Meanwhile, US inflation has been coming in hotter than expected. As a result, markets are now expecting the Federal Reserve to keep interest rates higher for longer. 

“With cracks appearing in US economic growth at the same time as inflation has looked more persistent, US equities have on aggregate struggled to make headway [in April], despite strong earnings results from most of the ‘Magnificent Seven’ mega caps”, says Lindsay James, investment strategist at Quilter Investors. 

“Progress from here will depend on economic fundamentals with a requirement for either more muted inflation data, allowing for rate cuts, or better growth metrics, making them less necessary”, she adds.

It is worth remembering that fund flows often lag behind market developments. This means the IA figures aren’t always representative of a market’s prospects going forward. For example, although UK equities continue to experience large outflows, the FTSE 100 actually soared to a record high last month.