The Fund Flows Paradox

April 21, 2012 at 11:26 pm 15 comments

How is it that the stock market has more than doubled over the last three years, when investors have been dumping stocks like they are going out of style? If you don’t believe me, and you think jovial investors are jacking stocks higher, then please explain to me why billions of dollars are hemorrhaging out of equity funds on a monthly basis over the last five years (see Fund Flow data chart below)?

Source: Calafia Beach Pundit

If by small chance you buy my argument that skeptical investors continue to doubt the sustainability of the three-year doubling in the stock market, then why is the Volatility Index (VIX) trading like investors are sunbathing at the beach while licking lollipops? For those not keeping score on the VIX (see also The VIX and the Rule of 16), typically a reading below 20 is interpreted as investor overconfidence and/or complacency. On the flip side, readings above 20 usually indicate pessimism or fear.

As you can see from the chart below, we have spent a good portion of the last few years on both sides of the 20 mph VIX speed limit, and currently at a reading of about 17, investors have slowed down to enjoy the scenery.

Source: Yahoo! Finance

So with massive selling and a cheery reading on the VIX, how can these bipolar data-points be reconciled? Therein lies the “Fund Flows Paradox.”

Take Me Out to the Ballgame

If you equate equity investors to fans at a baseball stadium, the fund flow data clearly shows investors are tired of losing money and have been leaving the game in droves. Instead of staying at the equity baseball stadium, those fatigued stock investors have decided to head over to the adjacent bond arena. The equity stadium will never completely be empty because financial markets always have speculative traders. In baseball terms you can think of these short-term traders as the emotionally volatile die-hard fanatics, who will stick around regardless of whether the home team wins or loses.

So while sentiment gauges like the VIX, or sentiment surveys conducted by AAII (American Association of Individual Investors) may be temporarily flashing contrarian bearish signals, one should be cognizant that these data points do not include the petrified opinions of investors who have raced out of the stadium. Eventually when the home team’s winning streak is long enough, investors will return back to the stadium from the bond arena. While there is no sign of individual investors coming back to the stock game anytime soon, in the meantime patient and disciplined investors have had plenty of opportunities to take advantage of. With massive numbers of individual investors and sellers sitting on the sidelines, the markets require relatively little buying to push prices higher.

Over the last few years, not only have equity valuations been broadly reasonable, volatility spikes during the last few summers have  also created amplified opportunities. With the wall of worries currently blanketing traditional and new media headlines (i.e., European crisis, U.S. election uncertainty, unsustainable and slowing profits, pending tax cut expirations, Mideast turmoil, etc.) there is no sense of urgency to pile back in to the equity markets.

The doubling in stock prices have occurred on low volumes, largely on the backs of a smaller institutional investor base, not to mention high frequency traders and speculators. While sentiment surveys may currently provide some insight into short-term equity trader attitudes, don’t let these volatile and unreliable data cloud the true underlying pessimism of the masses who have left the stock stadium in large numbers. Trillions of dollars remain on the sidelines as potential fuel for future equity appreciation, once confidence returns.

Opinions are interesting, but actions speak louder than words. Spend more time looking at the actions of the fund flow data, rather than the opinions of various short-term sentiment surveys or short-term options trader statistics. Adjusting your focus to investor actions and behavior will provide a truer gauge of overall investor sentiment and assist you in solving the “Fund Flows Paradox.”

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in VXX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

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15 Comments Add your own

  • 1. Sunday links: real expertise | Abnormal Returns  |  April 22, 2012 at 4:55 am

    […] A look at the “fund flows paradox.”  (Investing Caffeine) […]

  • […] April 21, 2012 at 11:26 pm Leave a comment […]

  • 3. keith piccirillo  |  April 22, 2012 at 10:17 am

    Timely and perfect game stock analogies in here. Well done.
    “Trillions of dollars remain on the sidelines as potential fuel for future equity appreciation, once confidence returns.” A bit perplexed about this because money never leaves the game, just as players in the dugout whose team is at bat are still playing. Investors have been leaving because they realise thateven good fund managers over the long term cannot beat their benchmarks owing to multiple reasons, fund expense being the primary one.

  • 4. keith piccirillo  |  April 22, 2012 at 10:28 am

    Timely and perfect game stock analogies in here. Well done.
    “Trillions of dollars remain on the sidelines as potential fuel for future equity appreciation, once confidence returns.” A bit perplexed about this because money never leaves the game, just as players in the dugout whose team is at bat are still playing. Investors have been leaving because they realise thateven good fund managers over the long term cannot beat their benchmarks owing to multiple reasons, fund expense being the primary one
    . Just how much do dark pools and such cause a lag in fund flow tracking timeliness, e.g., Lipper or Biderman?

    • 5. sidoxia  |  April 22, 2012 at 11:23 am


      Thanks for the note. Agree with your fund managers underperformance analysis (see also Charles Ellis article: ). May be a little metaphor mixing by me, but by money leaving the game I was trying to refer to all the cash in checking, savings, money market & Treasuries. If the markets continue to appreciate (win), those fearful dollars will eventually come back to the game, greedily chasing returns. If markets tank again like the bears think, then the cash will cozily wait on the sidelines.

      On dark pools, these are institutional trading platforms for individual securities and should have little to no impact on fund flows in my view, but a larger impact on the fund flows data is the rise of ETF investing and trading. My two cents…


  • 6. keith piccirillo  |  April 22, 2012 at 10:39 am

    • 7. sidoxia  |  April 22, 2012 at 11:26 am

      Thanks Keith! A well articulated bear case. I’ve listened to these bear arguments for the last three years and they’ve been continually wrong (absent the summer sell-offs). Maybe they’ll be right this year??


  • 8. Länkar vecka 16 « Smarta Investeringar  |  April 22, 2012 at 12:45 pm

    […] Fund Flows Paradox – Investing Caffeine Aktiemarknaden (USA) har mer än dubblats de senaste tre åren. Hur har det gått till när […]

  • 9. The Fund Flows Paradox « Systematic Relative Strength  |  April 23, 2012 at 8:53 am

    […] Great read by Wade Slome of Investing Caffeine about how the stock market has gone up so much over the past couple of years while fund flows for domestic equity funds have been massively negative. […]

  • 10. Sterling  |  April 23, 2012 at 10:57 am

    I was under the impression a good many hedge funds were trailing market returns and with the increased retail investor embrace of dividend stocks, and a possible dividend bubble, how do you rationalize the equity investor leaving in droves?

    • 11. sidoxia  |  April 24, 2012 at 8:42 am


      I don’t think the data supports the notion of a “dividend bubble,” although I do agree with the ideas that dividends are becoming more popular. Or in other words, for those still sticking around in equities, their is an investor bias shifting towards dividends. You don’t have to be be a brain surgeon to see 76 million retiring Baby Boomers are going to desire more income. As far as the dividend payout ratio goes, it is at record lows (~25%), which explains why dividends keep going up – companies still have plenty of room to raise them. Case in point: IBM today raised its dividend 13% today after recently reporting a quarter with flat revenue growth. When stock multiples are trading much higher (and dividend yields much lower), we’ll know there is a “dividend bubble.”


  • 12. 10 Monday PM Reads | The Big Picture  |  April 23, 2012 at 1:30 pm

    […] see also Fiscal and monetary policy in a liquidity trap ( • The Fund Flows Paradox (Investing Caffeine) • Origins of the Indebted American Homeowner (Bloomberg) • The Real Tax Rates of the Rich […]

  • 13. Just Bob  |  April 23, 2012 at 8:28 pm

    Your flow of funds analysis to explain the market levitation while retail investors flee to the exits omits the elephant in the stadium….. corporate stock buy backs. The corporate sector has the cash flow, liquidity and board authorizations to be, in your metaphor, both player and spectator.

    • 14. sidoxia  |  April 24, 2012 at 8:49 am


      Great points. There is no question that corporations are picking up some of the slack for the mass exodus of retail investors. Let’s not forget however, that in a ~$50 trillion global equity market it takes a lot of buying to move the needle. Moreover, secondary offerings, IPOs, and stock compensation issuance are continually adding supply of shares to the marketplace. But I hear you, as long as multiples remain low (and/or reasonable), and cash continues to pile higher, corporations will continue buying alongside the minority of equity investors still watching the game.


  • 15. Invtr  |  July 18, 2012 at 10:36 am

    There is no paradox. The market is controlled by pros and high frequency traders. Fund flows mainly are decisions of regular investors. They are just indicators of different populations. Who is right is the question here, not which data is right.


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