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U.S. Weekly Fund Flows – Investors Shrug Off The Market Rally, Are Net Redeemers Of Fund Assets For The Week

By Tim Roseen The markets rallied during the fund-flows week ended April 20, despite major oil producers’ failure to agree on a production freeze over the weekend. The major U.S. indices hit new 2016 highs during the week as investors cheered a drop in unemployment claims (the lowest since 1973), and banks rallied after oil strengthened and the dollar continued to weaken against its major trading partners. The rally was supported by companies broadly beating lower expectations at the beginning of this quarter’s earnings reporting season and on news that China’s first-quarter GDP growth of 6.7% was in line with expectations. While U.S. industrial output for March declined for the sixth month in seven – supporting fears of weakness in the manufacturing sector, the Empire State Index for April jumped to its highest level in over a year – showing signs of improving business activity in the New York Federal Reserve district. Modest declines in U.S. oil rig counts during the week and a reported labor strike in Kuwait helped prop up crude oil prices, despite a failed freeze agreement during the Doha, Qatar talks over the weekend. During the week, the Dow Jones Industrial Average closed above the 18,000 mark for the first time in nine months as investors kept their attention on better-than-expected earnings reports, despite the oil price dropping once again below $40/barrel. Investors appeared to be willing to take on more risk, bidding up emerging markets and out-of-favor sectors, with energy, materials, and industrials chalking up strong returns for the year to date. While IBM (NYSE: IBM ), Netflix (NASDAQ: NFLX ), and other tech firms’ earnings disappointed the markets at the end of the flows week, weighing on tech issues, a sixth straight week of declines in domestic oil supplies and a strong rebound in March existing home sales helped push U.S. stocks to 2016 closing highs and oil to a $42.63/barrel close. Nonetheless, for the week, fund investors were net redeemers of fund assets (including those of conventional funds and exchange-traded funds [ETFs]), pulling out a net $32.4 billion for the fund-flows week ended Wednesday, April 20. The headline number, however, was slightly misleading. Investors padded the coffers of taxable bond funds (+$3.5 billion) and municipal bond funds (+$0.6 billion) while being net redeemers of money market funds (-$32.0 billion) and equity funds (-$4.5 billion). For the second week in a row, equity ETFs witnessed net outflows, handing back $1.6 billion. Despite the equity rally during the week, authorized participants (APs) were net redeemers of domestic equity ETFs (-$1.2 billion), withdrawing money from the group for the first week in eight. As a result of the impasse between oil-producing nations for an output freeze, APs – for a second consecutive week – were also net redeemers of non-domestic equity ETFs (-$0.4 billion). The Industrial Select Sector SPDR ETF (NYSEARCA: XLI ) (+$401 million), SPDR S&P Retail ETF (NYSEARCA: XRT ) (+$400 million), and SPDR MidCap 400 ETF (+$322 million) attracted the largest amounts of net new money of all individual equity ETFs. At the other end of the spectrum, SPDR S&P 500 ETF (NYSEARCA: SPY ) (-$2.9 billion) experienced the largest net redemptions, while PowerShares QQQ Trust 1 (NASDAQ: QQQ ) (-$641 million) suffered the second largest redemptions for the week. For the sixth week running, conventional fund (ex-ETF) investors were net redeemers of equity funds, redeeming $2.9 billion from the group. Domestic equity funds, handing back $2.6 billion, witnessed their eleventh consecutive week of net outflows, while posting a weekly gain of 1.04%. Meanwhile, their non-domestic equity fund counterparts, posting a 1.33% return for the week, also witnessed net outflows (-$290 million) for a third week in four. On the domestic side, investors lightened up on large-cap funds and small-cap funds, redeeming a net $2.0 billion and $440 million, respectively. On the non-domestic side, international equity funds witnessed $264 million of net outflows. For the third week in a row, taxable bond funds (ex-ETFs) witnessed net inflows, taking in a little over $1.7 billion. Corporate investment-grade bond funds witnessed the largest net inflows, taking in $0.7 billion (for their third week in a row of net inflows), while government Treasury and mortgage funds witnessed the second largest net inflows (+$0.4 billion) of the macro-group. Flexible portfolio funds witnessed the only net redemptions of the group, handing back $211 million for the week. For the twenty-ninth week in a row, municipal bond funds (ex-ETFs) witnessed net inflows, taking in $425 million this past week.

The Future Of Beta – Slip Sliding Away…

Value, momentum, size, quality, volatility, etc., as factors in investing are quite popular. They’ve produced significant outsized returns relative to benchmarks. Now, we even have Smart Beta funds and ETFs popping up all over to make taking advantage of factors super easy. That brings up the critical question every investor interested in taking advantage of factors in their portfolio should ask – will the outperformance of factor investing continue in the future? Here I’ll take a look at a recent post from Alpha Architect that addresses this question. In short, investors should expect past outperformance to decrease in the future. Basically, there are two reasons why outperformance could go away; data mining (the factor is not real and just an artifact of the data) and arbitrage (basically investors becoming aware of the anomaly, investing in it in a big way, and thus it disappears). The Alpha Architect post references a study that looked at out of sample performance of factors. Below are the results. Basically, out of sample returns are lower than what the historical results had shown. The returns were about 40-70% of what they were in the past. Sobering. But as I’ve discussed on the blog in the past, some factors are better than others. In another post , a bunch of factors are analyzed and the only two sustainable ones are value and momentum. This is the reason all the strategies I use are primarily focused around these two factors. But one of the reasons that value and momentum work is that they come with periods of awful performance, absolute and relative, and drawdowns. All of which make them very difficult to stick with over the long term. And if history is a guide, investors should expect their relative outperformance to decrease going forward as more investors become aware of them. In a way, these factor strategies are even harder to stick with than just simple buying and holding of traditional index products. When you’re indexing at least you’re doing no worse than the index! There is no FOMO (Fear of Missing Out). If you’re not willing or able to tolerate underperformance, potentially for long periods of time, then you won’t be successful with factors. But I think the are a several things investors can do to increase their chances of success going forward. Reduce expectations: I always reduce potential outperformance by at least half when I look at implementing a strategy. Diversify: Use multiple strategies – buy and hold indexing, TAA, smart beta, individual stocks. There’s a very strong chance at least one of the strategies will be outperforming, thus increasing your chances of sticking with your program. It doesn’t and shouldn’t be all or nothing. Stick with what works – Value and momentum strategies have stood the test of time… at least so far. Dampen portfolio volatility with bonds. Reduce noise – There is a lot of noise in markets today. Investors need to work hard to tune it out. Try and go 1 month without looking at the market. Most investors I know can’t go a week. Have an investing process – Investing your money shouldn’t be haphazard and random. As with many things in life, having a system and process will help you achieve success. What are your goals? How does your portfolio match those goals? When do you rebalance? What strategies are you implementing and why? Do the same things at the same times on a regular schedule, etc… In summary, factor outperformance could very possibly decrease in the future. But they are still likely to be very powerful wealth building strategies if investors can stick with them and not expect the future to be exactly like the past.