The majority of media coverage of mutual fund flows tends to focus on short-term changes in dollar inflows and outflows and compare total equity to bond or money market flows at an aggregate level. But mutual fund flows contain additional signaling information that investors can use to gauge the popularity of different trading strategies and identify changes in market focus as well as other uses.
Long-term style trends
Fund flows can provide more information and to find it, we will drill down underneath the aggregates and look at fund flows both by style type and active vs. passive orientation and over longer time horizons.
Trends in flows by style and orientation tell an interesting story when we look at the last four years following the recovery from the financial crisis: Active management has remained popular and passively-managed exchange-traded funds and index-mirroring funds have both grown in popularity and experienced higher growth rates relative to active investors.
This can be seen in Figure1: Active equity income funds (+145%), ETFs of all flavors (+128%), and S&P 500 indexed funds (+82%) have seen the largest flows over the last four years. Actively managed growth/value aggressive funds (+59%); growth/value large cap funds (+59%); and growth/value small cap funds (+46%) have also proven popular. Unsurprisingly, taxable bond funds have experienced a 11% decrease in flows over this period.
What can we make of these trends?
The chart illustrates a number of secular (long-term) investing themes of the last four years. Investors want income. With bonds yields at historically low levels, investors have been willing to pay active managers to find it. ETFs have exploded in popularity as liquid vehicles to gain exposure to indexes, markets and alternative asset classes. Financial advisers and retail investors have been buyers.
Indexed mutual fund products continue to grow in popularity, a trend that continues from the 2000s. Financial advisers and investors have been moving assets into these low cost market-replicating products. Active management continues to attract assets as financial advisers and investors pour assets into active funds across the spectrum of capitalization, sector and style. The decline in bond funds is due to a low interest environment.
Top mutual fund families
Fund flow data is also available at the fund family level (Figure 2). Fund flow data by firm and total asset numbers are closely watched by the fund industry as a “scorecard” and can be used to see how different fund families are doing.
Do fund flows move with the market vice versa?
Research has shown that fund flows are a momentum indicator and closely track overall market moves. Over periods, fund flows and the market will move in a similar fashion. In fact, the correlation of long term fund flows and the S&P 500 is close to 100%. This makes it tempting to say that fund flows are the market and that money flows are the single drivers of stock prices. However, strong market performance also pulls assets in and negative results pulls assets out, making it an unsolvable chicken or egg problem.
Researchers have tried to construct trading strategies out of this long-term correlation. These have not worked because we can know the price of the S&P 500 today but fund flows are available anywhere from a week lag to a monthly lag. Because of this timing problem, a strategy using the lagging fund flow data is difficult.
Useful signals generated by fund flows for financial advisers are the secular and short-term trends in flows that can help you keep your finger on the pulse of current trends. Fund flows by type (active/passive) are also a useful indicator of secular market trends such as the search for income and the rise in popularity of ETFs and indexed products.
Changes are always of interest through their signaling function in which the changes reveal adjustments in risk appetite, lower or higher volatility, investment style changes, improved financial results or any number of variations.
Key changes to keep track of include: changes in style popularity, changes in income (dividend) popularity, changes in risk appetite, changes in popularity of asset classes (small cap/large cap), changes in national or international focus, changes in the balance between active and passive management, and ETFs.
Note on the fund flow data: Fund Flow data by style/product in Figure 1 is — except for ETFs themselves — ex of ETFs.
David Levine is the global head of investor relations analytics for NASDAQ OMX Corporate Solutions.