In Investing, Does It Pay to Follow the Money?

By Derek Horstmeyer Aug. 10, 2024 One line of thinking in the investing world is that it is better to follow the money—that is, the flows of investor dollars into and out of asset classes—as opposed to the opinions of Wall Street analysts.

My research assistants (Jonathan Pino and Artin Tatevossian) and I decided to test if this theory held up over time by examining how inflows and outflows, or the net buying and selling, from mutual funds and exchange-traded funds related to returns in various asset classes. In general, we found that if you have access to real-time inflow/outflow data then this information can yield better returns, but if you are reacting to last month’s flow numbers it provides little information on future returns.

To study this issue, we pulled all U.S. dollar-denominated mutual-fund and ETF data going back 50 years. We then examined the aggregate dollar inflows and outflows to these mutual funds and ETFs on a monthly basis. To further partition the results we separated our mutual fund/ETF sample by asset class: fixed income, money market, large-caps, growth, value and small-caps.

With this data, we then asked two simple questions: If there is money coming into a particular asset class, what return can I expect to get? And, if the opposite is happening and money is being withdrawn, what return can I expect in the asset class?

Not surprisingly, if you are looking at the real-time returns on inflows and outflows, it helps a lot to follow the money. For instance, if there is an inflow into large-cap stocks, then the average annualized return for that month is 13.64%. Yet if there is an outflow from large-cap stocks, then the average annualized return is 2.06%. This is a significant spread of 11.58 percentage points.

While the differences for large-caps are big, the results for fixed income, small-caps and growth stocks are even larger. For instance, for small-cap stocks, if there is an inflow into the asset class in a given month, the average annualized return in that month is 22.96%. Yet if there is an outflow from small-cap funds, the average annualized return in that month is negative 12.03%. This yields a difference in returns of 34.99 percentage points between months with inflows and those with outflows.

While this is all well and good, one may not have access to real-time inflow/outflow data, unless you are an institutional trader or work for a brokerage house given what would likely be a prohibitive cost for many individual investors.

So next we investigated if the previous month’s inflow/outflow data had any predictive power in the subsequent month’s returns. The results were nowhere near as good as the results that come from following real-time flows. In fact, it was a complete tossup—knowing the inflow or outflow data from the previous month didn’t help an investor predict next month’s returns.

For instance, for large-cap stocks, if you observed an inflow in a given month, the next month’s average annualized returns were 10.60%. Yet if you observed an outflow from large-caps in a given month, the subsequent month’s average annualized returns were 12.25%. In other words, last month’s inflow or outflow data don’t help investors make an informed decision about whether to double down on an asset class or leave it in the subsequent month.

In all, flows matter for returns only if you can view those flows in real time. If you are following the money based on month-old data, it doesn’t yield any excess returns. As they say, it is those with access to the information who truly have the advantage.

Derek Horstmeyer is a professor of finance at Costello College of Business, George Mason University, in Fairfax, Va. He can be reached at reports@wsj.com.

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