We are nearing the end of April, but it already feels like summer in the financial markets. Last week, US stocks had risen close to record levels. Similarly, European and Emerging Market stocks also rose more than 10% since their sell-off back in Q4-2018.
Some investors seem to use these ‘sunny’ days as an opportunity to save for ‘rainy’ days in the financial markets. US, Europe and Emerging Market equity funds all posted outflows last week. Year to date, Developed Market equities has seen a total outflow around 85 billion US$. As central banks are, once again, starting to become accommodative, other investors are betting on low volatility and a rally in markets. VIX - which is the well-known measure for the expected volatility implied by S&P 500 options - is close to historical lows. Latest data on April 23, from Commodity Futures Trading Commission (CFTC) also shows there were 178,000 short VIX futures contracts in the market. This is the highest number on record and demonstrates investors propensity to buy-in the market melt-up scenario.
Some key questions to consider here then. What would be the popular investment strategies in the coming months? How are investors positioned in certain themes? What does lower volatility mean in terms of funds flows?
Lower volatility, as a theme, tends to coincide with investor’s tendency to invest in more growth and momentum related stocks. In Figure 1, we can see VIX and flows to momentum mandated funds. In 2017 – a year of low volatility and goldilocks scenarios – we saw an increased interest in momentum funds. However, this began to change in early 2018 and we are yet to see an increase in interest towards momentum mandated funds. Last week, across 10 momentum funds tracked by EPFR, there was a total outflow of 50 million USD.
Figure 1. Flows to Funds with Momentum mandates vs CBOE VIX Index
Lower volatility, on the other hand, tends to coincide with a decrease in appetite toward stocks that have lower volatility. This might sound confusing, but in general, lower volatility stocks tend to outperform when the market is in turmoil. In Figure 2, we can see VIX and flows to low-volatility mandated funds. 2017 was a year of reduced interest in low-volatility mandated funds. But, with the increasing volatility in the last quarter of 2018, this changed. And we are still seeing an increased interest towards low-volatility mandated funds. Year-to-date, average weekly flows to 140 low-volatility mandated funds tracked by EPFR has been around 570 million US dollars. However, with the decrease in volatility in the last two weeks, flows have stopped.
Figure 2. Flows to Funds with Low-volatility mandates vs CBOE VIX Index
Investors tend to ride risk-on risk-off theme by moving their investments to more growth-linked momentum stocks in times of lower volatility. By looking at flows to certain funds, we might be able to capture the changes in the overall trends. Doing this helps us to understand the overall narrative and generate a better, consistent estimate of risk appetite.