Mutual Fund Cash Flows and Stock Market Performance*
During the decade of the 1990’s through the year 2001 there were some major shifts in the deployment of investment assets. Based on a variety of measures, mutual funds grew dramatically as vehicles for investing in portfolios of stock. Specifically net cash flows into equity funds grew from $13 billion in 1990 to $310 billion in the year 2000.1 During that same period the number of equity funds rose from 1,100 to 4,395, while the number of accounts in those funds increased from 22 million to 162 million. The cumulative effect of the new money injected into equity funds, together with reinvestment of dividends, plus the attendant stock price appreciation has produced a phenomenal growth in total net assets. The market value of those assets mushroomed from $239 billion in 1990 to $3,962 billion in 2000.
Granted that funds have become major players in equity markets, how important is their influence compared to other drivers of market performance? The investment press and business news media normally concentrate their attention on earnings growth, interest rate movements and other relevant financial and economic indicators. However, there is very little in the professional and academic investment literature comparing the impact of mutual fund cash flows to the aforementioned variables.
The purpose of this study is to provide some focus, comparison, and perspective on the importance of mutual fund flows. It presents evidence that mutual fund flows may be a very significant factor in explaining monthly-movements in stock market returns, and it provides some estimates on just how large the impact might be.
Specification of Variables and Causal Relationships
The basic model deployed in our study includes other important factors and liquidity variables in addition to mutual fund flows. The model specifies that the return on the stock market is a function of net flows into equity mutual funds, the growth rate of the M2 money supply, changes in the federal funds rate, and growth of earnings per share.
This study recognizes and acknowledges that movements of money into the stock market through mutual funds are linked to general business conditions. Clearly, company earnings and revenues and the external economic environment in which firms operate will influence investor decisions. However, that linkage between business performance and commitment of money to stocks is not rigid. Over short-term periods and even over extended lengths of time, masses of investors may be afflicted with either “irrational exuberance,” or they may be descending down a “wall of worry”.
Student Answer: Professional management and diversification are the major reasons investors purchase mutual funds, as well as they are easy to invest in for beginning investors or those who lack large amount of money as required by other types of investments. Investment companies are employed with experienced and profession fund managers who research and devote a lot of time to finding the perfect securities for their investment portfolios. The diversification allows for gains, even in a loss, because one investment in a mutual fund can offset the loss of another by it’s gains. Basically, your investments are scattered around and offer somewhat of a safety net for your
At the end of September and the beginning of October, stock prices began to decrease. The crash was caused by the nervous investors, which sold 16.9 million stocks on the New York Stock Exchange in one day. Many businesses invest most of their money in the stock market to make more money, but when the stock market crashes, so do businesses that have to shut down because they have no money. Most of the nation’s banks also failed because they had to put the depositors money in the stock market to increase, but when it crashed people lost most of their money. Many people started to lose faith in the stock market and “you can’t have a healthy economy without confidence in the market.”
On July 5, 2001, Kimi Ford, a portfolio manager at NorthPoint Group, a mutual-fund management firm, pored over analysts' write-ups of Nike, Inc., the athletic-shoe manufacturer. Nike's share price had declined significantly from the beginning of the year. Ford was considering buying some shares for the fund she managed, the NorthPoint Large-Cap Fund, which invested mostly in Fortune 500 companies, with an emphasis on value investing. Its top holdings included ExxonMobil, General Motors, McDonald's, 3M, and other large-cap, generally old-economy stocks. While the stock market had declined over the last 18 months, the NorthPoint Large-Cap Fund had performed extremely well. In 2000, the fund earned a return of
Ross, S.A., Westerfield, R.W., Jaffe, J. and Jordan, B.D., 2008. Modern Financial Management: International Student Edition. 8th Edition. New York: McGraw-Hill Companies.
However, EMH has been the most controversial subject of research in the field of financial economics during the last 40 years. “Behavioural finance, however, is now seriously challenging this premise by arguing that people are clearly not rational” (Ross, (2002)). Behavioral finance uses facts from psychology and other human sciences to explain human investors’ behaviors. 2. What is the difference between a MAIN BODY A generation ago, it was generally believed that security markets were efficient in adjusting information about individual stocks and the stock market as a whole (Malkiel, (2003)).
The economic system of the United States and the rest of the world were once based on industry and the manufacturing of goods. As the profits from these industries began to be unable to keep up with the demand of three percent annual growth, the amount David Harvey feels is necessary to prevent crisis, investors began looking to the higher profit margins that the financial markets can achieve. This ...
William Sharpe, Gordon J. Alexander, Jeffrey W Bailey. Investments. Prentice Hall; 6 edition, October 20, 1998
In turn everything in the present and the future is judged through the stocks as they hold a high importance in industrialized economies showing the healthiness of said countries economy. As investing discourages consumer spending over all decreases, it lead...
We analyzed the market for two weeks to determine when the equity market would turn from a bearish to bullish market. Without a change in the market and a declining bond price, we decided to invest in equities according to our investment strategy, which brought us into the second phase of our portfolio. Therefore, at the beginning of February we bought shares in Sirius, Microsoft, Neon, Washington Mutual, and Nike. As assumed, the equity market continued to plummet decreasing the value of all our stocks except for our Gold Corporation stock.
Capital Asset Pricing Model (CAPM) is an ex ante concept, which is built on the portfolio theory established by Markowitz (Bhatnagar and Ramlogan 2012). It enhances the understanding of elements of asset prices, specifically the linear relationship between risk and expected return (Perold 2004). The direct correlation between risk and return is well defined by the security market line (SML), where market risk of an asset is associated with the return and risk of the market along with the risk free rate to estimate expected return on an asset (Watson and Head 1998 cited in Laubscher 2002).
In the paper published by Xiong (2010), it is presented that a portfolio’s total return can be disintegrated into three components: the market return, the asset allocation policy return in excess of the market return, and the return from active portfolio management. The asset allocation policy return refers to the fixed asset allocati...
Chapter 11 closes our discussion with several insights into the efficient market theory. There have been many attempts to discredit the random walk theory, but none of the theories hold against empirical evidence. Any pattern that is noticed by investors will disappear as investors try to exploit it and the valuation methods of growth rate are far too difficult to predict. As we said before the random walk concludes that no patterns exist in the market, pricing is accurate and all information available is already incorporated into the stock price. Therefore the market is efficient. Even if errors do occur in short-run pricing, they will correct themselves in the long run. The random walk suggest that short-term prices cannot be predicted and to buy stocks for the long run. Malkiel concludes the best way to consistently be profitable is to buy and hold a broad based market index fund. As the market rises so will the investors returns since historically the market continues to rise as a whole.
I became an enthusiast of finance ever since I was at high school. At the political economy class, my teacher asked us: if you have a million RMB, how would you use it? She then introduced us the concept of investment, and I was intrigued specifically by the stock. For the latter two years of my high school, I have been reading books and articles regarding the stock market in the U.S. and in China. As one of the outstanding students ranked top 1% in College Entrance Exam in Hainan Province, China, I was accepted by the City University of Hong Kong with a full scholarship. With the strong interest in finance, I chose quantitative finance and risk management as my major.
Following the trend of economy, it is important to investors to understand that strong economy creates strong stock market. To elaborate further, as stock prices are increased by current and future expectations of earnings, thus without a strong economy it would be difficult for the companies to increase and sustain their earnings (Kong 2013). The economy development is usually calculated using the gross domestic product of a countries. On the other hand, a change is the stock price can also cause a major impact to the consumers and investors directly. Hence, a loss in confidence by investors can cause a downturn in consumer spending in the long term, which will also affect the economy’s output (Aysen 2011). The graph below shows the relationship of stock market price (KLCI) and the GDP of Malaysia in 2009. Thus, it can be concluded that the economy and the stock market has a positive relationship.
I am currently majoring in Finance Management. Most of the time people think of finance as just managing money. However, finance is needed for so much more! The finance industry deals with starting businesses, developing new products, expanding markets, as well as everyday things like saving for retirement, purchasing a home, and even insurance. The stock market, asset allocation, portfolio analysis, and electronic commerce are all key aspects in finance. In this paper, I will explain how these features play a vital role in the industry, along with the issues that come with these factors.