What's Your Strategy to Avoid Selling Low and Buying High?

Thursday, March 24th, 2016
Written by Manifold Fund Advisors

This February saw a break to the longest streak of monthly equity mutual fund outflows since 2008. For the week ended March 16, 2016, the Investment Company Institute (ICI) reported that total estimated inflows to mutual funds were just over $6 billion. This is the fourth positive week in row after seven consecutive months of negative net flows.

After several years of smooth equity returns, volatility returned in the fall of 2015. However, equity mutual funds have seen net outflows of over $99 billion since April of 2015, which was the last month for positive net equity fund flows. Over that same time period, bond funds in general saw outflows of around $64 billion. In concert with this, ICI’s class of hybrid funds, which are not completely equity or fixed income, have also seen proportional flows. As of March 16, total money market funds assets were around $2.7 trillion.

This reflects an interesting, and sometimes unfortunate, relationship between mutual fund flows and trailing equity returns. Since 2014 on a monthly basis, higher trailing market returns (S&P 500 in this case) have been positively correlated with positive fund flows. However, as volatility and diminishing market returns began to come into play, fund flows in general, as well as equity funds specifically, saw increases in outflows. In short, we are realizing our losses.

Graph 1: Equity and Total Fund Flows compared to S&P 500 12 Month Returns

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Sources: https://www.ici.org/research/stats/flows/flows_02_24_16, S&P Dow Jones Indices LLC/FRED

The common mantra is to “stay the course” and invest long term. However the data indicates that not only have advisers stopped doing so, but are actually compounding failures by selling after a market decline and buying after a recovery. I often repeat my statement that a client’s time horizon is a maximum of ninety days—or whenever they read their next account statement. That doesn’t mean a long-term investment plan lacks value, but our human emotional biases cause us to react to headlines, fear, greed, and quarter end account values. History tells us that long-term investing is prudent; common sense tells us that we need to balance the strategic plan with managing emotions (and investments) in the shorter term.

Successful investing is about managing the tensions between investment objective, risk in the market and human nature. Our research focuses on how to manage this tension and seeks to determine the best combination of investment strategies for different markets, the optimal asset allocation, monitor relative performance, and use feedback to adapt to a constantly changing investment environment.

Graph 2: Equity and Total Fund Flows compared to S&P 500 12 Month Returns 1/1/2014 through 3/16/2016. Predicted Total Fund Flows is a linear regression of Total Fund Flows.*

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It’s time to re-think the strategic approach of portfolios. At Manifold Fund Advisors we take the view that asset classes and categories are not the only aspects of diversification that should be examined. In fact, the first aspect we look at in building a portfolio is the diversification of investment strategies. The key from our perspective is identifying which strategies and products work together and how they interact.

Asset allocation has tended to work over long periods of time and in markets that maintain an upward trend. However, we believe we can identify active managers who might be able to add value through security selection as a second tier to an overall portfolio. Our third level of strategic allocation is through tactical investment strategies that can be fully invested or fully out of the market. We know certain tactical strategies may periodically outperform or underperform other active and passive strategies, and vice versa.

In our quest for preparation over prediction, we look to provide optimal exposures of passive, active, and tactical strategies in order to be prepared for any market condition we may encounter.

* Total Fund Flows exclude Money Market Funds

The Investment Company Institute (ICI) is the national association of U.S. investment companies (mutual funds, exchange-traded funds, closed-end funds and unit investment trusts). ICI encourages adherence to high ethical standards, promotes public understanding of funds and investing, and advances the interests of investment funds and their shareholders, directors, and advisers.

The S&P 500 Index has been widely regarded as the best single gauge of the large cap U.S. equities market since the index was first published in 1957. The Index does not incur fees or expenses and is not available for purchase.

Disclosures

The views expressed are those of the author as of the above date, are subject to change at any time and over time, and may differ from the views of the firm as a whole.

Past performance is no guarantee of future results. Investing involves risk. The investment strategies and products discussed are not appropriate for every investor. When investing in mutual funds, an investor should consider the investment objectives, risks, and charges and expenses of a fund carefully before investing. The prospectus contains this and other information about the fund. Individual investors should review with their advisors the terms and conditions and risks involved with specific products or services. Manifold Fund Advisors, LLC makes no guarantees on the completeness or accuracy of information provided herein.

The asset allocation, diversification and other strategies discussed in this article do not ensure a profit and cannot protect against losses in a declining market.

No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of Manifold Fund Advisors, LLC.

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