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A Look at Mutual Fund Flows


I guess a 6% dip might not be so bad.


Investors are performance-chasers. They are very much a society with a credo of "what have you done for me lately", and they reward those who have done well and punish those who have not.

Their reward for a job well-done is more money. Like the owner who tosses her dog a treat for every trick, investors throw money to fund managers who have put up the best quarterly returns, and the managers are only too happy to snap up those dollars.

Markets have done well lately, and investors have taken notice. They've been tossing their treats to fund managers, so today we're taking a look at Mutual Fund Flows.

What is it?

There are some services available which track on a daily basis the flows into and out of various mutual and exchange-traded funds. By watching the demand for stocks, bonds and other investment classes, the idea is that traders can take advantage of knowing where the money is flowing.

For long-term investment purposes, tracking daily fund flows is a bit of overkill - we needn't go any further than the free data provided by services like AMG Data or the Investment Company Institute (ICI). While time-delayed, the data is still useful for long-term investment purposes, and has served to give several important warning signs of potential excess.

Focusing on the ICI data, on a monthly basis they take a survey of the U.S. mutual fund industry, reporting on such trends as total assets under management for various types of funds, liquid assets held in reserve, monthly inflows and redemptions, etc.

By monitoring this data over time, we can see how much money investors are putting in or taking out of the industry, which can help us determine if investors in general are taking things to excess compared to their historical behavior.

Why should we follow it?

Because of the way the industry is structured, it's unusual to see investors redeem shares en masse. In fact, any time we have seen more cash leave the industry than enter it, it's been an almost infallible buy signal for the broader U.S.

A bit more difficult is determining when things have gotten out of hand at the opposite extreme, but it's still possible. One way is to simply look at the average monthly inflow over the past few months, which is what the chart below shows.

Another way is to compare money market assets to total stock fund assets, which will show us when risk preferences have gotten to one extreme or the other. These signals have been rare, but very telling when they occur.

What are the challenges in using it?

The data from the ICI is only released monthly, and with a one-month delay, so we have to have a long-term time frame in order to have any potential use for it. Obviously anyone with a short-term time frame is going to have difficulty in using this for day-to-day trading decisions.
Due to the long-term and broad nature of the data, solid signals are rare – maybe one per year. This is not the type of indicator that is going to get you in at every market bottom and out at every top.
As with most indicators of this nature, determining what is "extreme" can be difficult. But the usual steps of detrending the data can take care of long-term trends and is helpful.
What does it look like?
What's it suggesting now?

Last month, the three-month average of net inflows reached $31 billion+, the highest amount of any other three-month average except for during the first quarter of 2000.
Not only that, but money market assets as a percentage of stock fund assets reached its lowest level in 20 years of data, lower even than August 2000.
What's most disturbing about that last fact is that the rates paid on money market assets have skyrocketed over the past couple of years – more than doubling in that period. So we're seeing investors ignore the higher "risk-free" rate on MMA's at the same time we're seeing companies like E-Trade (ET) record huge jumps in trading volume.
We have seen this kind of behavior only three other times in the past two decades. Two of them led to a market crash (September 1987 and August 2000) while the third to a 6% correction in the S&P (August 1994).
Caveat Emptor.
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No positions in stocks mentioned.

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