Fidelity [profile] suffered big net outflows last month, but not as big as it looks like. Blame it on its huge 401(k) business.

Per Morningstar's monthly mutual fund flows report, released today, the Boston Behemoth suffered $9.182 billion in net outflows in July, more than double any other fund firm. It actually had net inflows of $920 million into its passive mutual funds, yet that was overwhelmed by $10.101 billion in outflows from its active ones.

Yet it looks like Fidelity's special situation, a kind of "it's not as bad as it looks" phenomenon, is causing Morningstar to change its fund flow reporting ways. As Alina Lamy, senior analyst in Morningstar's markets research, notes in the report, "a large portion of Fidelity's outflow is a reflection of continued transfers from mutual funds to collective investment trusts ... occurring since December 2013." Per numbers Fido folk provided to M*, of that $10.101 billion in net active mutual fund outflows last month, only $4.124 billion was actual outflows; the remainder, almost $6 billion, actually went into collective trust versions of the same Fidelity funds. By that estimate, taking the passive flows into account, Fidelity only suffered $3.204 billion in net mutual fund outflows in July, just ahead of Franklin Templeton ($3.173 billion) and below Pimco ($4.56 billion).

Here's what appears to be going on, and it all goes back to the law that created the modern mutual fund industry in the U.S., 75 years ago. The Investment Company Act of 1940 says that each share in a mutual fund has to be treated equally: equal share of the gains, equal access to redemptions, and, crucially, equal share of the costs. Thanks to the creation of mutual fund share classes, essentially mirror image mutual funds running on the same strategy, fundsters today have some additional pricing flexibility. But they still have to charge each institutional share the same price, regardless of the client.

Here's where collective funds (also known as collective trusts, collective investment funds, or collective investment trusts) come in. Mutual funds are securities products regulated by the SEC under the '40 Act. Collective funds are bank products, regulated by the OCC and state banking commissioners. Unlike mutual funds, collective funds are institutional-only products, which is how they're allowed to get away with a key differentiating feature: flexible pricing. Large 401(k) plan sponsors and other investors eligible to use a collective fund can negotiate their pricing with the folks running the fund. That, and the lower compliance costs and the like thanks to not being under the disclosure-heavy '40 Act, has made collective funds increasingly attractive to 401(k) plan sponsors, from medium-sized employers on up. And as the largest 401(k) recordkeeper (by number of plan participants) in the business, Fidelity has lots of clients to potentially convert from one structure to the other.

Stay tuned for how Morningstar handles this conundrum going forward. 

Stay ahead of the news ... Sign up for our email alerts now
CLICK HERE