“If a tree falls in a forest and no one is around to hear it, does it make a sound?”
It’s a philosophical thought experiment that raises questions about perception and observation.
Is sound only sound if someone hears it?
Can something exist without being perceived?
Some investment managers focus on fund flows to understand how large institutional investors are positioning their capital. If I paid attention to it, I would probably focus more on the trend for extremes rather than the level or direction of flows. I believe the crowd does the wrong thing at the wrong time and that includes most professional investors and portfolio managers. So, I expect it would be a contrary indicator that I could quantify to be true. After money flows out of funds at an extreme, it’s probably a good time to buy their shares.
Fund flow is the net of all the cash inflows and outflows in and out of a fund or asset class. In the last few months of 2018, we heard a lot about capital flowing out of high yield bonds.
Below is the fund flows of high yield funds tracked by Lipper.
We can see how it matches the price trend of the SPDR® Bloomberg Barclays High Yield Bond ETF.
We don’t have to look at an actual fund flow calculation to understand the supply and demand of the fund.
If something doesn’t show up in price, does it really matter?
Would the fund flow matter if it wasn’t enough to drive the price trend?
My answer is “No.” So, I skip the fund flow and focus on the price trend.
The price trend is ultimately all that matters and I don’t need to follow fund flows to see the asymmetry in supply and demand.
If enough money is flowing into a fund or group of funds, it’s going to drive the price up. If it doesn’t eventually drive the price up, why would we buy it?
Eventually, all strategies are trend following. To earn a profit, we need the price to rise.
Well, when it comes to high yielding markets like high yield bonds there is the exception. Since it pays a yield, the price could stay flat for years and we would still earn a return. In fact, I like to tactically buy yield when it’s high and that necessarily means when the price has fallen. For example, as the High Yield ETF declined in price, its yield increased to 6%.
If we had bought it at the lower price, we would expect to earn about 6% from that point forward. Now its price has trended up, the yield if we invested today is down to 5.65%.
However, since my focus is on Total Return (Price + Yield) I could say there is still some element of trend following.
We see it when we compare the three-year price only chart to the Total Return. When we observe based on price alone, the trend is down. When we factor in the dividend yield, it’s an uptrend.
It’s all a matter of perception and observation.
For useful insight, perception and observation need to be complete.
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