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Mutual Fund Flows

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So...large outflows are good, unless they're bad?

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In Buzz & Banter this morning, Greg Collins mentioned the flow out of equity mutual funds for the latest week as reported by AMG Data. At $2.4 billion, this was the largest outflow since the week ended March 12th, 2003 (which coincided with the market low). The only other time we've seen an outflow approaching $2 billion since then was the week ended October 1st, 2003, which once again coincided with a low as the market rose steadily into early 2004 (see chart below).

Mutual fund flows tend to be coincident to market moves, in that they tend to rise and fall with the market. Perhaps because the summer months tend to be weak, so do mutual fund inflows. There is a bit of a chicken-and-egg problem here - does the market usually fall because fund inflows slow down, or do fund flows slow down because the market is weak? I'm not sure of the answer to that one, but I do know that extremes in fund flows tend to be something of a contrary indicator, so the large outflows in the latest week actually make me a little more bullish than I was otherwise.

There is one very big caveat to all this, however, and that is the historically low level of mutual fund cash levels. I've showed before how cash levels at fund firms have an extremely high correlation to short-term interest rates, so the very low short rates we've seen tell us that we should expect lower-than-average mutual fund cash levels (after all, if cash has such a paltry yield, what's the incentive for these guys to park their money there?). However, that doesn't change the fact that funds have relatively little cash on hand. If we see continued outflows from these funds, at some point they will exhaust their cash reserves for all practical purposes and will have to sell assets in order to meet redemptions. This could start a very vicious cycle and it bears watching.


No positions in stocks mentioned.

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