Fund Flows and You

I talk about mutual fund inflows and outflows a lot here on TRB, but I want to make clear what fund flows mean and what they don’t mean as an indicator.

First off, by “fund flows”, I mean the dollar figures moving in and out of US equity funds for our purposes here.  The flow of cash in and out of bond funds is a separate discussion.

Anyway, US stock mutual fund flows are fairly meaningless in determining the direction of the stock market.  They predict nothing, they merely react in real-time to the whims of the non-institutional investor.

As such, mutual fund flows from week to week are a coincident indicator, not a leading or a lagging one.  They are most helpful for gauging investor sentiment and the psychology of the crowd.

Take a quick look at this chart I dug up from Vanguard to see just how coincident these flows are, compared to the S&P 500 in this instance:

As you can see, other than a stretch between 1990 and 1994, there is very little difference between flows and market performance, directionally speaking.

Why are mutual fund flows so well correlated with real-time sentiment?  My guess is that this is because they offer daily liquidity.  For example, John Q. Ab-Roller is sitting around the house, not doing crunches, and all of a sudden he happens to see a brutal market update during the news.  He can call or log in to his brokerage account, sell his mutual funds and receive his cash redemption based on that night’s closing NAV.

This process also works in the reverse manner, if say John Q. Ab-Roller is out on the golf course listening to a buddy regale him with the tales of monstrous profits to come by owning China funds or Brazil funds.

You will see and hear plenty about fund flows throughout the year, just try to keep in mind that they are a sentiment measure only and coincident with market moves for the most part.  They are not indicative of what’s to come.