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”.
Despite the increase in volatility, the NASDAQ Composite Index is up by 15.4% for 2007 and by 28% since the last MoneySoft M&A Outlook was published. During the same period, the Dow Jones Industrial Average has moved from 10,705 to 13,930—an increase of 30%, but the market is “wobbly.”
The Financial Crisis of 2007-2009 was one of the hardest financial times in the United States since the Great Depression. This was a time where many financials institutions failed, housing markets collapsed, and when banks had to be bailed out by the government. This caused the unemployment rates to increase, homes to be foreclosed, and the interest rates to fall. With all of these different systems failing, it raised concerns for many investors if their money was safe in Money Market Mutual Funds.
There are many risks that people take in their lives. Yet, investing in the stock market is one of the riskiest things to do. All the money that has been saved over years, possibly saved over a lifetime, could all be lost in the blink of an eye. The Great Depression was triggered by the most well-known stock market crash in history, another crash happened in 1987, and one could happen any moment. However, people invest to make money and through this simulation strategies and a basic understanding were compiled to get a perspective on the risk and tasks involved in investing.
The aim of this report is to evaluate and validate passive investment strategies and advantages of having index funds in the portfolio. The importance of passive investment strategy is initially justified with the help of theory on efficient markets. The report then provides evidence that indexing still is a vital aspect of investment strategy and is not influenced by the efficient market theory. The report also gives a brief overview on how investors utilize indexing to minimize transaction cost by replicating the market index in their portfolio. Further, the success of indexing in US, UK and bond markets is highlighted with the help of evidence from past research on passive investment strategies. The later section of the report provides brief introduction of behavioral finance and how psychological biases affect investor’s behavior and prices. It also provides its contrasting viewpoint with respect to the Efficient Market Hypothesis (EMH) and analyzes the effects of mispricing on average returns achieved by investor.
Fama, E.F. and French, K.R. (2004). The Capital Asset Pricing Model: Theory and Evidence. The Journal of Economic Perspectives, 18, 3, 25-46. Retrieved December 2nd, 2011 from jstor.org
In a recent study titled “No Bulls for Bear Mountain”, Bank of American Merrill Lynch reported investors have amassed the largest stockpile of cash since 2001 and have cut equity holdings to a four-year low. As bond yields continue to fall and an increasing amount of interest rates around the world are turning negative, investors are more likely to
Investors familiar with the saying “don’t put all your eggs in one basket”, can comprehend the rationale behind the modern portfolio theory, pioneered by Harry Markowitz (1952). This is one of the most significant and influential economic theories in investment and finance. The theory was further developed by William Sharpe (1966) who along with Merton Miller, the three were awarded the Nobel Prize in Financial Economics in 1990.
During the economic and market uncertainties, investors may rotate their funds out of stocks and into the relative safety of bonds
According to Perold (2004), ‘CAPM can be served as a benchmark for understanding the capital market phenomena that cause asset prices and investor behavior to deviate from the prescript...
M. Statman, S. Thorely, and K. Vorink, (2006) investor overconfidence and trading volume: review of financial studies 19
Hensel, C. R., Ezra, D., & Ilkiw, J. H. (1991). The Importance of the Asset Allocation Decision.
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...
In this research paper, we examine the distinct theories of traditional and behavioural finance, linking them to efficient market hypothesis. The scope of the paper covers market anomalies as well as behavioural biases of individuals/analysts and the impact of such on portfolio construction. Over the last two (2) decades, behavioural finance has been growing steadily. This growth is associated with the realization that investors rarely behave according to the assumptions made in traditional finance and economics.
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.
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.