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Watching the Fund Flows

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It’s been a good couple of months for the American stock markets, with the Dow Jones industrial average rising by about 5.8 percent year-to-date as of March 8th. You might think this would lead to more people rushing to put their money into mutual funds, but that hasn’t been the case. Inflows into domestic equity funds have been dropping as we move further into 2012. All told, American stock funds have seen a net outflow of $2.28 billion through the end of February. And the bloodletting has been getting worse: The week ended February 29th, the most recent week for which we have this data, saw a whopping $3 billion flow out of domestic equity funds. That’s the worst week we’ve seen all year.

Interestingly enough, business has meanwhile been booming for foreign equity funds. Foreign stock funds took in about $1.9 billion in January, and another $3.9 billion more in February. Year-to-date, foreign equity funds have taken in about $5.86 billion in new assets. While domestic stock funds lost assets in three out of the five weeks that ended during the month of February, their foreign counterparts were positive in all five weeks.

Foreign stock funds aren’t the only vehicle that’s running roughshod over domestic equities. Bond funds continue to draw in much more money, taking in more than $65 billion in new assets so far in 2012. That divides up into $51 billion for taxable bond funds and $14 billion for munis.

Even hybrid funds, those that invest in both bond and stock instruments, have been much more popular than stock funds throughout 2012, attracting nearly $17 billion in new assets so far this year. It seems that even investors who want exposure to equity funds would rather leaven those offerings with bond funds as well. Mutual fund investors — who can be expected to be more conservative with their money than people buying individual stocks directly —  would rather buy just about anything besides American stocks.

Even before the downturn of the stock market began in October 2007, domestic stock funds were feeling the pinch. In August of that year, investors pulled over $18 billion out of those equity funds. Is it possible that fund investors were sensing that the market was precarious and was about to collapse?

A closer look

The data doesn’t bear out that interpretation. Fund investors do not tend to be ahead of the curve on major drops in the stock market. The market was falling more or less continuously from October 2007 to March 2009, but the biggest single months for outflows during that period were October 2008 ($44 billion), January 2008 ($35 billion), and September 2008 ($28 billion). If equity-fund investors were trying to time the market, they weren’t doing a very good job of it. They seem to have been simply running scared.   

To be fair, in 2008, everyone was running for cover. The data compiled by the ICI shows only seven individual months since the beginning of 2007 when bond funds suffered through net outflows. And the losses in those months are all fairly minor, less than $5 billion in each of them — except for the three months from October through December 2008. That December saw outflows of $7 billion, November lost $14 billion, and October, when the entire financial system seemed to be collapsing upon itself, lost a whopping $41 billion. 

Fund investors do, however, adapt quickly to changed surroundings. March 2009 was the absolute nadir of the stock market, with the Dow bottoming out on March 9 at 6547, the lowest it had closed since 1996. It was on March 10th that the market began its long climb back up. Flows into domestic equity funds turned strongly positive in April, with investors plowing more than $9 billion back into them. That’s the highest that figure had been for any month since February 2007.

The rise of domestic equities

Of course, there’s another effect here as well. With more money moving into domestic equity funds, domestic equities themselves are going to rise in value. Does that mean it’s worthwhile to track fund inflows as a signal for subsequent upward moves in the market? There might be something to that theory.

Consider: The biggest single months for equity inflows since the market bottom in March 2009 have been May 2009 ($13.5 billion), January 2011 ($10.5 billion), April 2009 ($9.2 billion), and February 2011 ($7.3 billion). Each of those months was followed by a month in which the Dow increased in value:

April 2009: 7.4 percent

February 2011: 2.8 percent

May 2009: 4.1 percent

March 2011:   0.8 percent

Some of them are obviously stronger months than others, but even a monthly increase of 0.8 percent translates to an annual increase of 9.6 percent. That’s nothing to sneeze at.

There have been other points, of course, when the Dow rose strongly without any additional help. In September of last year, for example, investors pulled $13 billion out of domestic stock funds, but the Dow still went on to record its highest monthly point gain ever in October. Still, if you’re watching the fund flows, you might take note of large inflows into domestic stock funds.