Recent mutual fund flow data provide some interesting insights into the stock and bond market. While US equity funds have recorded net outflows of $86.5 billion YoY, bond funds have seen inflows of $169.9 billion, according to EPFR-TrimTabs. However, the contrarian view of fund flows reveals that such data does not always tell the full story.
For example, in recent years, US equity funds experienced net outflows annually from 2016 through 2020, coinciding with strong market performance during that time. In contrast, they saw inflows in 2021, which came right before the bear market of 2022. Bond funds followed a similar pattern, experiencing their largest inflows in years in 2021, then suffering massive losses in 2022.
It’s worth noting that the relationship between fund flows and market performance isn’t always straightforward – sometimes the inverse relationship manifests quickly, while on other occasions it can take longer. As a result, fund flow data can’t be used as a simple market timing indicator. However, the general trend suggests that huge inflows are often followed by mediocre or negative returns, while significant outflows tend to be followed by better returns.
Overall, contrary to what one might expect from looking at raw data alone, mutual fund flows can provide valuable insights and illuminate contrarian approaches to investing in the stock and bond markets.
The ETFs Paradox: How Extreme Flows Affect Their Performance
Research has shown that the relationship between ETFs and inflows/outflows is a slippery slope. The biggest outflows on average have led to outperformance for ETFs over those with the largest influxes. This pattern has been reported in various academic studies, including one that appeared in the Review of Finance two years ago.
Another study published last summer in the Review of Financial Studies pointed out investor exuberance as a possible cause for underperformance. The study disclosed that narrowly focused ETFs, created to take advantage of investor tendencies, struggle on a risk-adjusted basis by an average of 5% per year for five years following their launch. These ETFs typically receive massive cash injections soon after their release only to underperform shortly after.
These studies establish a paradox that exposes pertinent challenges concerning the distinction of positive and negative liquidity. Experts must address these challenges to create more efficient capital markets and investment opportunities for diversified returns.
Investors’ Obsession with Artificial Intelligence
A recent study found that stocks owned by exchange-traded funds (ETFs) with the term “AI” in their name performed better than those without. The finance research letters are reminiscent of the late 1990s internet bubble, where stocks performed well when their names included “dot com.” The phenomenon provides an essential contrarian lesson, best articulated by Warren Buffet, to “be fearful when others are greedy, and greedy when others are fearful.”
Despite the S&P 500 gaining over 15% in 2023, investors are on balance pulling their money out of U.S. equity funds. This fact is encouraging from a longer-term perspective. If retail investors had been quick to jump on the bullish trend, it would suggest a weaker “wall of worry” to support the bull market.
More: The Stock Market Takes a Breather After a Burst of Strength
Plus: JPMorgan Analysts Warn that Stocks May Head for Punishing Selloff due to “Unknown Unknowns.”
