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The recent discovery of an interesting article on portfolio diversification got me thinking about this commonly accepted strategy amongst investors.  Walter Upgrave, senior editor for Money Magazine and “Ask the Expert” financial columnist, was the composer of the piece and in it, he addressed the question “I have about $1 million spread into 33 funds. Is that too many?”

Though having so much capital to invest that this even becomes a concern at all isn’t a ‘problem’ everyone shares, the question can still pervade portfolio inquiries of investors of any kind. In short, the answer was yes; with the premise of the article being “diversifying your portfolio is a good thing, but is it possible to have too much of a good thing?”

In this case, it is.

One of the reasons for this is that having too many mutual funds or ETFs within a portfolio exposes the investor to more company or sector risks. This, in turn, can negate the returns they were hoping for in the first place.

Though Upgrave can’t provide a finite number of funds that will best suit any investor, a good rule-of-thumb he offers is that anywhere between five and 10 should do the trick. Go beyond this and you’re likely to see things get a bit sticky. Something else to consider when seeking a diversification equilibrium is that it isn’t so much the number of funds you have, but rather, that your portfolio is meeting your financial needs. Depending on your age, will your portfolio be generating enough income without risking complete decimation should the financial markets take another dive?

When building a portfolio with diversification in mind, it is possible to achieve it with fewer funds spanning a wider variety of investments. Different advisers will provide varying allocation percentages, but most remain congruent with a roughly balanced mix of stocks (both US and foreign), bonds, mutual funds, and alternative investments.

Though still experiencing a relatively new serge in popularity (think post financial crisis), alternative investments are establishing a more permanent spot in an increasing number of investor portfolios. Hedge funds, managed futures (metals, foreign currencies, etc.), real estate, commodities, and derivatives contracts are some examples of popular alternative investments. In terms of diversification, the most alluring aspect of allocating a portion of your capital into investments of this kind is their obvious non-correlation to the stock market (i.e. the stock market crashes, this component of your portfolio won’t always go down simultaneously).

We all know that too much of a good thing can often mitigate desired results, and the same idea seems to apply to portfolio diversification. I think Warren Buffett says it best: “wide diversification is only required when investors do not understand what they are doing.”

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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LeapRate today announced a new forex volume index.  It is intended to provide an estimate of retail spot forex trading volume. The reported inputs into the estimate are “…monthly and/or quarterly activity levels put out by various retail FX brokerage firms; similar activity levels announced by other FX aggregators such as Forex ECNs and FX settlement firms; as well as anecdotal evidence we encounter as part of our general research activities in the Forex sector.” This isn’t something that will be of much use on a day-to-day basis for traders, but it does offer some insights into the retail forex business in general.

The index shows volume rising from about $100bln per day back at the start of 2006 to having reached above $200bln a couple of times in the last few years. That’s not a bad growth rate over the span.

It should be noted, though, that even with the big increase in volume since 2006, retail forex volume remains only a tiny fraction of the overall forex market. The latest LeapRate estimate has average daily volume in the $175bln area. The latest data we have for the inter-bank markets in New York, London, Tokyo, Sydney, and Singapore put average daily spot volume at about $1.640trln (the $5trln figure often noted includes swaps, forwards, etc. as well). That means retail flow is about 11% of the global figure (see The Most Traded Currency Pairs for a more specific review).

Here is the current chart:

There have been some concerns expressed about flattening volumes of late thanks to increased regulation (particularly in the US and Japan) and lower market volatility. There’s no doubt that regulation has increased as the CFTC and NFA have moved on several fronts to tighten things up in the US (largely motivated by Dodd-Frank) and much has been done to reduce leverage in Japan. There’s been considerable discussion on those developments in the last few years – much of it derogatory. I, for one, think they have gone a long way toward getting rid of the old “Wild West” aspect to retail forex trading, at least in the US.

On the volatility side, as you can see from the weekly EUR/USD chart below, it has indeed dropped off in recent times. This is seen in the falling Average True Range (ATR) line in the lower sub-plot. It is telling us that weekly ranges (averaged over 14 periods) have fallen to their lowest levels since the financial crisis was developing in the latter part of 2007. This, however, is about in line with where volatility was during much of the 2003-2006 period, so we may just be seeing a reversion to more normal levels.

If volatility is indeed just mean-reverting then it has implications for the forex business. Things have already become increasingly competitive in recent years. That is only going to become even more intense if lower volatility keeps trading volumes subdued.

The interesting thing to watch will be whether the big push in the area of automated “mirror” or “follow” trading through initiatives like the Currensee Trade Leaders program draws in more investment oriented capital and thereby increases retail forex volumes, both outright and in terms of the retail share of the overall forex volume pie. That is certainly something which is very possible. New developments like that can help the retail forex business continue to grow over time, even if volatility doesn’t move back up to higher levels.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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Our Two Cents – Week of 5/29/12

Summer has arrived. After last weekend’s gorgeous weather in Boston as we honored Memorial Day, we erased our cravings for hamburgers and hot dogs and replaced them with hunger for some knowledge of the currency markets.

In the U.S., economic optimism continued. The May Thomson Reuters/University of Michigan’s index on consumer sentiment rose to its highest level in four years. According to the survey, consumer sentiment increased to 79.3 from 76.4 in April. The highest jump since October 2007, the survey also showed half of all consumers felt the economy has improved during the last year. Jobless claims, which remained at 370,000, also illustrated economic stability.

While conditions in America painted an optimistic picture, images abroad weren’t cast in the same stroke. Greece remained much of the focal point as the country devised plans for a parallel currency to the euro, should it withdraw from the region. Sergey Shvestov, vice president of Russia’s Central Bank, said Greece’s departure from the eurozone was necessary, and it would be a “good example” for other countries. Facing discussions about debt issuances, German Chancellor Angela Merkel defended her opposition about why bonds won’t solve the eurozone’s problems, saying such tools wouldn’t get to the root of the problem. Ultimately, the Organization for Economic Cooperation and Development warned the 17-member region that a severe recession looms if its governments and central banks don’t act quickly to improve economic conditions.

For hedge funds, an overwhelmingly majority of them added compliance staff since 2008, according to a new survey. Hedge fund redemptions for May 2012 upped 3.31 percent, according to the GlobeOp Forward Redemption Indicator.

• Consumer Sentiment Rises to Highest Level in Four Years, The New York Times, May 25, 2012
• Greece Already has Plan for Parallel Currency to Euro – Russian Central Banker, Forex Crunch, May 25, 2012
• Overwhelming Majority Of Hedge Funds Add Compliance Staff Since ’08, FINalternatives, May 24, 2012
• Jobless claims little changed last week, Reuters, May 24, 2012
• Merkel: Makes No Sense To Solve Problems With Euro-Zone Bonds , The Wall Street Journal, May 24, 2012
• Euro zone officials agree to prepare for Greek exit scenario, Reuters, May 23, 2012
• Hedge Fund Redemptions Up In May, FINalternatives, May 22, 2012

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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An article on CNNMoney about Greece’s pending decision on exiting the euro (or the “Grexit,” as it is called) brought up a very good question: why isn’t more attention being paid to what the country’s choice will mean for the US? The clock certainly has not stopped ticking and the election that will likely make or break the country’s euro membership is set to take place next month.

Well, the good news is that in terms of trade, the US economy will hardly feel the tremors produced by the potential Grexit threat, should it materialize. Only a meager 0.1% of American exports go to Greece, with 14% going to the euro zone in general. If Europe is shaken by their decision, US trade should come out relatively unscathed.

The place of worry with this situation is actually a bit more speculative. Economists fear that should a Grexit occur, it could trigger big time panic amongst investors, who will then make mad dash bank runs, which in turn will further disrupt the Euro that includes bigger debt-laden countries. How’s that for looming dark cloud syndrome?

With over 20% of all loans that happen in the US coming from European banks, a debt selloff could potentially hinder their willingness to lend. Though US banks have been actively reducing their exposure to peripheral euro zone countries, a great deal more exposure to the wider euro zone in general still remains.

Does this mean the US should really start focusing on a contingency plan should Greece decide to return to the drachma?

View the full article here.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

U.S. stock prices are no higher today than they were in 1999, and the purchasing power of the major market indices has made no progress in fifteen years.  Meanwhile, the yield available on ten-year Treasury bonds has dropped from close to seven per cent in the mid-1990s to below two per cent.  Not surprisingly, the superior investment performance generated by default-free Treasuries has severely dented the notion that equities are the safest asset for long-term investors.

The sub-par returns generated by stock markets over the past decade has been accompanied by a marked change in the asset allocation of defined-benefit pension plans, with many corporate sponsors electing to reduce their equity exposure and increase their fund’s weighting in fixed income securities.  The latest corporation to effect such a change and capture public attention was Ford Motor Company, who announced earlier this year that it intended to lift the proportion of its pension fund assets invested in bonds to 80 per cent, up from 45 per cent previously.

The trend towards the de-risking of defined-benefit pension schemes has sparked an avalanche of commentary from so-called investment experts, who argue that the asset allocation switch is misguided and could prove to be anything but riskless should the yield on Treasury bonds increase from generational lows to more normalized levels.

Of course, similar arguments were made more than a decade ago when Boots, the British pharmacy retailer, liquidated its entire equity portfolio and moved all of its pension fund assets into high-quality fixed income securities.  Importantly, then as now, the arguments are bogus and demonstrate a complete lack of schooling in elementary financial theory.

The decision to replace equities with bonds in a defined-benefit pension scheme is not a call on the long-term returns expected from either asset class, but a strategy to reduce financial risk, by investing pension plan assets in securities with a duration that better matches the duration of liabilities.  Minimizing the volatility of the value of pension plan assets relative to pension liabilities reduces the probability that a company will have to divert capital and make costly deficit contributions, most likely at a time when the firm can least afford them.

It is important to appreciate that holding equities in a defined-benefit pension scheme increases a firm’s overall leverage, and in turn, the expected costs of financial distress.  Although a defined-benefit pension fund and its corporate sponsor are legally separate entities, the economic reality is very different, and since the company is ultimately liable to meet the pension liabilities, the balance sheets should be consolidated to give a complete view of the firm’s capital structure.

Suppose a firm has $1,000 in operating assets financed by $250 in debt and $750 in equity, which gives a debt/equity ratio of one-to-three.  The capital structure appears to be relatively conservative, but suppose the company has pension liabilities of $500 and pension assets of $500, with $350 invested in stocks and $150 in bonds.  The stocks can be thought of as ‘negative firm equity,’ and the bonds can be regarded as ‘negative pension liabilities.’

A complete picture of the firm’s capital structure, which includes the pension plan in the calculation of leverage, shows that the debt/equity ratio increases from one-to-three to 600/400 or three-to-two.  The pension plan’s asset allocation seriously increases the firm’s overall financial risk, and the observation clearly matters, since academic research confirms that such information is impounded in stock prices.

Further, should the market determine the capital structure to be appropriate, it is still not suitable because the company is forgoing the opportunity to exploit the valuable tax shield that would arise from financial leverage on its own balance sheet.  The same capital structure could be achieved and the tax shield utilized by switching the pension plan’s stock holdings into bonds, while issuing the same amount of debt at the corporate level and using the proceeds to repurchase an equivalent amount of its own shares.  This is akin to the strategy adopted by Boots in 2001, which was so widely criticized at the time.

The de-risking of defined-benefit pension plans continues with Ford Motor Company recently announcing its decision to increase its bond allocation to 80 per cent.  The strategic move has been challenged by investment professionals, who fail to appreciate that just as there are two sides to every story, there are two sides to every balance sheet.

Perhaps the last word on this controversial issue should be left to the late Fischer Black, who wrote in 1980, “My message is simple.  Almost every corporate pension fund should be entirely in fixed dollar investments.”

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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A few weeks ago, one of our contributing writers, John Forman, posted on when the best time of day to trade Forex was. The question was inspired by the Q&A session of our last Trade Leader webinar featuring Currensee’s Taylor Growth, who explained the benefits of using a conservative Forex trading strategy.

Recently, we were able to get some insight on this question from another Trade Leader; Gabor, Asirikuy Trading. Gabor trades using a technical strategy based on indicators such as Chart Patterns, Bollinger Band, RSI, Stochastics.

Gabor says:

“It depends on the currency pair. The rule of thumb is that the bigger the liquidity of the market, the better to trade it. Liquidity is changing during the day even for heavily traded pairs. E.g. the London session is considered to be the best time to trade the European majors (EURUSD, GBPUSD, USDCHF). Big liquidity does not necessarily mean directional price movement – we can experience the formation of congestion zones many times during liquid hours. But when balance between bulls and bears is broken during a highly liquid period, chances are that it is going to be a meaningful movement, the beginning of a trend.

To support my statement, I examined one of the short-term trend following systems that I trade at Currensee.

It’s a momentum-based strategy, which trades the H1 EURUSD. If price momentum reaches a certain threshold, the system opens a market order in the direction of the momentum. In other words, if the open/close of the hourly candle is bigger than a preset % of the daily volatility, we enter the market. I ran a simulation of 12-year price data and then grouped the market entries by hour. The result is shown on the chart.



As you can see, most entries are in the overlap of the European / US sessions which starts in the range of 1 p.m. GMT (New York) – 2 p.m GMT (Chicago). This lasts to the last hour of the London/Frankfurt session,  5 p.m. GMT. The Asian / European overlap is the second most busy period from 8 a.m to 10 a.m GMT.”

It is interesting to compare this response to that given by Trade Leader Taylor Growth. Since he is a range trader, he feels that the lower trading volume in the NY afternoon, Asian, and early-European sessions yield the highest success rates. He explained that the best time of day to trade really depends on the strategy the trader is using. Since his conservative strategy is very technical, it fares better in Asian sessions when trading European pairs. Since it’s nighttime in Europe while the Asian markets are most active, no European news releases are making their way out and influencing trades.

To see how these two Trade Leaders’ trading strategies have been working for them, check out the Leaderboard.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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Today, the Facebook black hole sucked yet another casualty into their never-ending post-IPO news onslaught: Morgan Stanley. The bulge bank is currently under investigation by regulators for their potential involvement in some Facebook pre-IPO foul play.

As the lead underwriter of Facebook’s IPO, Morgan Stanley apparently had some inside info on the social network in regards to the future success investors could see after the company went public. Rueters reported that a Morgan Stanley analyst had downsized his revenue projection for Facebook after the network filed documents with the SEC stating there was a chance their revenue could struggle as it’s users attention was turned to mobile devices. The question now that’s ruffling feathers of the FINRA and SEC members is ‘did certain investors receive privileged pre-IPO information that should have been shared more liberally?’

This allegation brings up a very interesting correlation: how the massive influx in tech startups, and in technological advancements in general, is affecting the big banks. For Morgan Stanley, it’s in equity underwriting. An article on CNNMoney revealed the firm has landed deals to underwrite IPOs of some of the biggest names in the web biz, like LinkedIn, Groupon, and of course, Facebook – which have all generated $1.2 billion in fees. As the tech revolution keeps on trucking, Morgan Stanley becomes increasingly reliant on its tech deals for revenue generation. Right now, 13% of their investment banking fees are produced by these deals (Goldman pulls in about 9%, while JPMorgan takes 7% of theirs from tech).

Now this is where things could get messy for Morgan Stanley. If the looming Facebook-IPO-info situation does blow up, their juicy chunk of equity underwriting fees could be looking a little less hearty – fast.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

I bet right about now Jamie Dimon at JP Morgan is quite pleased to have the Facebook fiasco all over the news to take some of the spotlight off his little derivatives problem. As I write this (Tuesday morning), JPM is up 5% and FB is down nearly the same amount on the day. Personally, I think there’s way too much being made of the whole Facebook IPO story – though I do think the NASDAQ system problems is an interesting story, especially after the BATS failed IPO a little while back – but admittedly the rest of the news has gotten rather stagnant. I actually begged CNBC via Twitter on Friday to talk about something, anything, but Facebook, but struggled to come up with a good alternate subject.

Naturally, there’s a blame game going on as to whose fault it is the stock has taken a dive. We can never really know how things would have turned out if the NASDAQ system had functioned properly, but that won’t prevent folks from trying to do so. Finding someone to blame, of course, is a favorite pastime these days. Traders certainly do it when they take losses. After all, it can’t be my fault I lost money on my position. It must be those evil banks, unethical brokers, or speculators gone wild (unless, of course, they are moving prices the direction I want).  Yes, I am a speculator. Obviously, I’m talking about the other speculators, though – especially the ones with computers faster than mine. Yeah, the high frequency guys. It’s all their fault! They’re preventing me from moving out of the 99% and in to the 1%. Something really needs to be done about them.

Thankfully, today we’ve returned to the on-going back and forth between European central bankers and political leaders over what to do about the mess. It’s kind of refreshing after the all-Facebook-all-the-time chatter. Everybody seems to want Greece to stay in the euro, but it looks like we won’t find out until the middle of June as to whether the Greek people share that view. You’ll notice the German rhetoric on the subject of austerity and whatnot has cooled considerably. Could that be because suddenly they aren’t doing all that great either and the weak euro that’s coming out of all this actually tends to help Germany more than most on the export side of things?

Then there’s the on-going question of whether the US can remain out of the fray and avoid too much in the way of economic damage from all the European issues. I’m moving to England in the fall to start work on a PhD, so you know I’m looking for the dollar to go on a fantastic run higher to make my greenbacks go farther. Unfortunately, the UK retained the pound rather than join the euro. The photo going around of David Cameron with arms raised celebrating Chelsea’s performance against Bayern Munich in the Champions League final on Saturday (at last an English team beat a German one in penalties!)  alongside a much less enthused Angela Merkel could just as easily represent the British feeling about having their own currency through all the mess.  I’m hoping the Bank of England decides to do more QE. That ought to sink the pound.

In the meantime, back to my charts.

Oh look! There’s a cup-and-handle setting up on the weekly USD Index chart. Maybe the markets will help me get cheaper pounds without the QE.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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Our Two Cents – Week of 5/21/12

Even though the unofficial start of summer kicks off this Memorial Day weekend in Boston, flip flops and sunscreen were out in full force last weekend. What was the temperature of financial markets from the past week? Read on to find out.

In the U.S., the economy was picking up after an early spring slump. Data showed growth in the April-June quarter is off to a good start, thanks to falling gas prices and solid hiring gains. Manufacturing and housing continued to show signs of economic expansion as factory bookings for long-lasting goods rose 0.3 percent last month, according to a May 24 Commerce Department report. Other numbers showed purchases of existing and new houses also increased. In the business sector, about 72 percent of startup CEOs reported thoughts of economic optimism this year in a study conducted by Silicon Valley Bank.

For the eurozone, unfortunately, there haven’t been too many signs of economic confidence after fiscal turmoil continues in Greece. The country is facing a possible exit from the eurozone that could cost the region hundreds of billions of euros. Greece’s financial minister said he expects the financial disorder to last about 12-24 months, allowing time for Greece to decide if it wants to stay in the single eurozone currency. As Greece struggles with itself, European leaders have prepared crisis-fighting plans for discussion at an informal EU Summit this week. According to the European Central Bank, officials said the eurozone needs growth and austerity.

In April, hedge funds upped 0.12 percent, according to the HFRX Global Hedge Fund Index, which puts their year-to-date gain at 3.27 percent.

• Euro zone needs growth and austerity: ECB’s Asmussen, Reuters, May 21, 2012
• Manufacturing, Housing Probably Improved: U.S. Economy Preview, Bloomberg, May 20, 2012
• Euro zone market turmoil to last 12-24 months: German finance minister, Reuters, May 18, 2012
• Time for Europe to step up, Forex Crunch, May 17, 2012
• Looking For Optimism About the Economy? Ask a Startup [INFOGRAPHIC], Mashable, May 17, 2012
• US economy picks up after early spring slump, Associated Press, May 17, 2012
• Hedge Funds Up 0.12% In April, FINalternatives, May 16, 2012

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The secular bear market in stocks that began during the autumn of 2000 is at an end; at least, that’s the verdict of the uber-bulls, who argue that a sustained multi-year upswing in equity prices is now underway.  Unfortunately, the bullish thesis is predicated on suspect assumptions; perhaps none more so than the argument that the individual investor – following four consecutive years of net outflows – is set to embrace the stock market once again.  This view is not supported by the historical evidence however, and displays an almost complete ignorance of individual investor behaviour amid a protracted period of sub-par returns.

It is important to appreciate that mutual funds’ net cash flows are determined not only by the level of new sales, but also by redemption activity.  Both variables are positively correlated with stock market returns, whereby higher equity values precipitate an increase in new sales AND redemptions.  Further, new sales typically exceed redemptions during secular bull markets, while the converse is generally true through a prolonged period characterised by declining stock market valuations.

The pattern-seeking nature of humans means that individual investors react slowly to a pronounced change in the climate for equity investing, such that the level of new sales weathers the first marked decline in stock prices – during a secular bear market – relatively well.

However, a second strike has a lasting impression and leaves deep scars, such that the level of new business falls well short of that recorded at the height of the previous secular bull.  Further, it takes several years of strong returns to entice the individual investor back into the stock market.

While increased risk aversion depresses the level of new sales as a secular bear market progresses, loss aversion means that individual investors are typically unwilling to liquidate their positions during a period of stock market weakness, and postpone redemptions until equity prices stage a cyclical recovery.  The bottom line is that the combination of weak sales and elevated redemptions means that equity mutual funds can expect to endure net cash outflows for an extended period.

It has been argued that the net cash outflows suffered by equity mutual funds from 2007 to 2011 is an unprecedented development, but this observation simply confirms the dangers of utilising data that extends back no further than the mid-1980s.  The Investment Company Institute, the national association of U.S. investment companies, maintains a far more instructive data set that documents mutual fund activity since 1945.

A multi-year advance in stock prices began during the summer of 1949, and although net cash flows were positive throughout the 1950s, the deep scars left by the collapse in equity values during the ‘Great Depression,’ meant that it took more than a decade of robust returns for a new generation of investors to embrace stock market risk.  Net cash inflows gathered momentum as the 1960s progressed, and the net assets of equity mutual funds surged from $17 billion at the start of 1961 to $48 billion by the decade’s end.

The secular bull market struck a speed-bump in 1966, but individual investors remained unfazed in the face of falling equity values, and net cash inflows continued uninterrupted.  However, the near-thirty per cent decline in stock prices from the winter of 1968 to the summer of 1970 tempered investor enthusiasm, and the surge in redemptions as the equity market recovered – combined with lacklustre new sales – saw equity mutual funds suffer their first net cash outflow in post-war history.

The net cash outflow recorded by equity mutual funds in 1971 marked the beginning of a sustained period of negative flows, which persisted until 1982 or almost twelve years – far longer than the current four-year period.  Importantly, cyclical rallies in stock prices, which ranged from the 28 per cent advance between late-1971 and early-1973 to the 57 per cent gain from late-1974 to the autumn of 1976, did not ease the industry’s woes, as the surge in redemption activity on each occasion overwhelmed the increase in new sales.

Data for the period show that net cash outflows from equity mutual funds were consistently greater during cyclical recoveries in stock prices than they were during cyclical declines.  For example, the cumulative outflow during the upturn in the stock market’s fortunes from the spring of 1978 to the winter of 1980 was 27 per cent of assets, or more than double the level recorded during the previous downturn.

Recent trends in equity mutual fund flows are consistent with historical experience.  The annualised rate of new sales versus net assets is running at little more than half the level recorded during the latter half of the 1990s, and is well below the rate observed during the five-year cyclical advance in stock prices beginning in the autumn of 2002.  Meanwhile, redemption activity is responding to the surge in stock prices since the autumn of last year, such that net cash flows remain decidedly negative.

Increased enthusiasm for equity investment by individual investors is been used as one of the reasons to support the thesis that a multi-year upswing in stock prices has just begun.  A review of the historical evidence however, suggests that this particular hypothesis is bunkum.

Previously posted on www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.