Opinion: Why You Should Worry About The New Cash Flood In US Equity Funds

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American stock funds are now navigating a river of new cash from investors, and that’s not a bullish sign. Many investors may see this differently – that a large cash inflow is a good thing. In fact, cash flows are the opposite indicator – the US stock market has performed better in the past when there is a net cash outflow.

The evidence is summarized in the chart below, which shows the net cash inflows to US equity funds (both open and publicly traded funds) by year over the past decade. Note that in all but two of the years since 2010 there have been net outflows. This 2010-2020 period was extremely strong for US stocks. However, during this time, US equity funds experienced a net outflow of $ 741 billion. (Data is from TrimTabs, a part of EPFR, a division of Informa Financial Intelligence). This year so far is experiencing a major reversal of this long-term trend. During the first four months of this year, according to TrimTabs, US equity funds have received net inflows of $ 142.3 billion. If this pace were to continue throughout the year, there would be $ 427 billion of net inflows in 2021, representing more than half of the total outflow from 2010 to 2020. A study that puts this huge year-to-date inflow into a Bearish light appeared last December in the Review of Finance. The study, titled “ETF Arbitrage, Non-Fundamental Demand and Return Predictability,” was conducted by David Brown of the University of Arizona, Shaun William Davies of the University of Colorado Boulder, and Matthew Ringgenberg of the University of Utah. The researchers found that, on average, ETFs with the largest outflows outperformed ETFs with the largest inflows up to a year after these extreme flows. Another academic study that reached a similar conclusion has been circulating since January. Titled “Competition for Attention in the ETF Space,” the study was conducted by Itzhak Ben-David and Byungwook Kim from Ohio State University, Francesco Franzoni from the University of Lugano in Switzerland and Rabih Moussawi from Villanova University. The researchers focused on specialized ETFs that are created to capitalize on investor fashions and market trends, and which typically receive a large influx of cash shortly after launch. They found that these ETFs during their first five years after launch lag behind in the market on a risk-adjusted basis by 5% per year on average. The tenuous relationship between yield and cash flows is also evident in the accompanying tables. The first lists the 10 ETFs with the best returns to date. The second table lists the 10 ETFs with the highest net inflows. (Return data is from FactSet; flow data is from CFRA Research). Notice that none of the backgrounds in the first table appear in the second.

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The data returned is from FactSet; flow data is from CFRA Research

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The data returned is from FactSet; flow data is from CFRA Research).

Mark Hulbert is a regular contributor to MarketWatch. Your Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com More: The US market CAPE is now the highest in the world and this gives little coverage to equity investors. Also read: A safe prediction about the future of the stock market is that it will be nothing like the past.