What determines flows?

A presumption derived from herding behavior is, flows follow performance: Investors are scared to buy at market lows and then come storming in well after a bullish move is underway.

This seems so apparent on the face it scarcely warrants a cocked eyebrow. A corollary should apply to factors affecting markets as well: In the case of the dollar, we should have every reason to expect American investors to keep their funds parked at home when the dollar is strong and chase foreign assets higher when a declining dollar is making them more expensive.

The net monthly flows for the four categories of U.S. and world stock and bond funds provide both confirmation and denial of the “flows follow performance” maxim. Both categories of stock funds clearly enjoyed massive net inflows during the late 1990s bull market, while U.S. stock funds were sold with abandon in mid 2002.

However, as we will see here, U.S. investors resumed buying world equity funds but not domestic equity funds during the 2003-2007 bull market.

Moreover, buyers of domestic bond funds were aggressive in mid-2002 and again in 2006-2007. The first period corresponded to a bull market in bonds and a bear market in stocks; the latter occurred in precisely the opposite environment. This cursory examination indicates we can make no blanket statements on the order of “flows follow performance.”