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PrimoTenore

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PrimoTenore's Blog : When to Get Into Mutual Funds?

October 24, 2008

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In spite of my own awesomeness at picking individual stocks, I'd still like to put a fair chunk of cash into mutual funds during this downturn and let someone else do some of the work.

But I'm wondering about timing this move a lot more than I'm wondering about when to buy stocks.

Karen Dolan at Morningstar writes today that the outflows from mutuals is still proceeding at a record pace. All this redemption is forcing fund managers to make some very tough and probably bad decisions because they have to sell positions to give the panicked sheep their money back.

As Dolan says:

"[F]und trades motivated by shareholder cash flows are more costly than voluntary trades motivated by research. At its worst case, depending on the liquidity of holdings in the portfolio, redemptions can trigger a vicious cycle that can really drive down a fund's value."

So, even though I'm willing to buy stocks a little early and ride the rest of the way to the bottom before the upswing, I worry that the selling in mutuals will continue past the actual market bottom and continue to create a drag on their results even after the rest of us have started to make money.

I know Mack is a student of mutual fund inflows and outflows, so maybe he can supply some wisdom. Is it a simple matter of watching the outflows and trying to call a bottom on that independently of the actual market performance? Anyone else have a hypothesis?

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MackTheKnife Date

October 24, 2008 12:40 Edited: October 24, 2008 by MackTheKnife Abuse this post

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Howdy, PrimoTenore!

-- I know Mack is a student of mutual fund inflows and outflows, so maybe he can supply some wisdom. Is it a simple matter of watching the outflows and trying to call a bottom on that independently of the actual market performance? --

Biting my tongue concerning the comparative merits of actively managed mutual funds versus index MFs, I believe a historical study of MF flows could indeed be helpful in timing one's purchases.

Also useful could be historical studies of the relationship between the behaviors of major equity-market indices such as the Standard & Poor's (S&P) 500 (http://www.zacks.com/research/report.php?type=estimates&t=SPX&x=0&y=0">SPX), S&P MidCap 400 Index (http://www.zacks.com/research/report.php?type=estimates&t=MID&x=0&y=0">MID) and S&P SmallCap 600 Index (http://www.zacks.com/research/report.php?type=estimates&t=SML&x=0&y=0">SML) on the one hand and the level of margin debt at the New York Stock Exchange (NYSE) on the other hand.

Concerning my own historical study of the relationship between the performance of SPX and margin debt at the NYSE, I am looking forward to the next release of the margin-debt data. I suspect it fell to about $265 billion in September from about $292 billion in August.

Meanwhile, there are other methods one could employ in timing incremental purchases of MF shares, as follows:

Factoids for a Freaky Friday -- During the last bear market, the above-referenced indices all bottomed in October 2002 circa the following levels on my weekly charts:
SPX: 768.63
MID: 370.83
SML: 169.64

Based on these three data points, one could time certain MF purchases to more or less coincide with the contemporary equivalents of these levels, depending on the respective MFs' investment styles.

Good luck!

MackTheKnife

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