Go with the fund flows

Source: The Sunday Times
Author: Goh Eng Yeow 24/4/2011

For many investors, one way to strike it rich is to hunt for undervalued stocks and buy into them in the hope that their attractiveness will eventually be recognised by others.

But the way in which stocks everywhere seemed to be moving in lockstep with one another during the global financial crisis three years ago has cast great doubt on whether such conventional wisdom in share investing is still valid.

Instead, investors have done considerably better in their investments when they find themselves guided by the flow of funds moving in and out of markets.

Take last month, when the widely watched Nikkei 225 Index in Tokyo plunged by almost 20 per cent in two days, following a devastating earthquake and tsunami in Japan.

For most of us, it was a sign of the gloom and doom stalking the Japanese stock market as it grappled with a potential environmental disaster triggered by the damage caused by the earthquake to a nuclear plant near Tokyo.

But what most of us missed at that crucial moment was the huge amount of fresh money - almost US$1 billion (S$1.26 billion) to be precise - that was pumped into a large New York-listed fund, known as the iShares MSCI Japan fund, which specialised in investing in Japanese blue chips.

Flush with new funds, the iShares MSCI Japan fund then swung into action, buying into depressed stocks in Tokyo in a big way, helping to set off a spectacular V-shaped rebound in the Nikkei 225 which enabled it to regain half of its losses in the next few days.

In hindsight, Japan's central bank was believed to be the driver behind the huge inflow of money to the fund, as it raced to calm the tremors on the financial market and prevent indiscriminate dumping of Tokyo stocks by jittery investors.

Traders who kept their nerves during those trying few days and followed in the footsteps of the iShares MSCI Japan fund in snapping up Tokyo blue chips would have profited handsomely.

For market watchers like us, it is the latest demonstration of how tracking fund flows can be a profitable exercise for investors.

Indeed, big investment banks like Citigroup and Morgan Stanley now regularly issue reports which analyse trends in fund flows, measuring the amount of money entering and leaving different markets.

Based on such information, investors can sometimes work out whether a market is overheating or unloved.

Some retail investors have, however, complained that the reports issued by these research houses are available only to their rich clients, who then enjoy an unfair advantage in switching in and out of markets profitably, based on the fund flow data to which they have access.

I disagree. As a market writer, I watch fund flows very closely. They usually confirm for me the trend which I am already seeing in the market.

And when turmoil hits the market, like it regularly did during the recent global financial crisis, fund flows become an important gauge of investor sentiment.

Let me give you an example: In late 2006, there was a flood of new money into funds investing in Asian stocks propelling regional bourses to stage their own bull runs. In December of that year alone, a staggering US$3.2 billion of inflow was recorded.

Singapore was a particularly big beneficiary of the fresh flow of funds as it was perceived by foreign investors as the gateway to Asia, and this propelled the benchmark Straits Times Index past the 3,000-point level for the first time.

It turned out that the deluge of foreign money into the region was so huge that in the subsequent 10 months, the STI rose by a further 28 per cent to a record 3,850.

What the fund flow data at that time showed was a regular inflow of fresh funds into funds specialising in regional equities - and any investors would have made a handsome profit just by riding on the trend during that super-bull run.

And while fund managers and sophisticated investors might have access to the fund flow data first, retail investors certainly had plenty of time to climb onto the gravy train as well, even though they only got the fund flow reports from the newspaper a few days later.

But by December 2007, the fund flow data showed that institutional investors were busily locking in their profits and jumping ship, selling billions of dollars' worth of Asian shares each week, as the mortgage crisis in the United States threatened to pull the rest of the world down with it.

Just before US investment bank Bear Stearns imploded in March the following year, the data showed that foreign fund managers had pulled a record US$10.7 billion from Asian markets in the previous 10 weeks. It amounted to a screaming sell call on equities, one might say.

And those who had heeded the warning signal would have been spared the agony of seeing their investment portfolios suffer a meltdown as the STI plummeted by a staggering 50 per cent when another US financial giant, Lehman Brothers, collapsed six months later.

The fund flow data also offered investors an inkling of when to re-enter the market when sentiment was at its most gloomy, following Lehman's demise.

In a black fortnight between the end of February and early March in 2009, the global banking system teetered on the edge of collapse as the US banking giant Citigroup broke US$1 in share price, while HSBC Holdings tumbled 24 per cent in one day.

But those who followed fund flow data would have noticed that investors had started streaming back into the region, pouring US$583 million into China stocks alone in just one week that February.

It turned out to be a master stroke, with financial markets experiencing a V-shaped recovery, as they responded to the measures made by then newly inaugurated US President Barack Obama to calm the global banking panic.

So how can an investor take advantage of the trend provided by the fund flow data?

To make it easy for investors to put their money into markets rather than individual stocks, investment banks have created a new type of investment known as the exchange traded fund.

These are funds listed on the Singapore Exchange which are traded like shares, but which track the performances of actual stock market indexes like the Straits Times Index and the Hang Seng Index.

In recent years, they have become highly popular because of the low management costs - about 0.3 per cent of the total asset value of the fund.

So, given the vast changes in the global financial landscape, rather than stock-picking, it may be time to consider market-picking as part of your investment strategy. Happy investing!

engyeow@sph.com.sg