Our previous post examined how index providers and asset managers launch “hot” thematic/sectoral indices and funds to capitalize on stories. Who can blame them? Money always flows in to assets with strong recent performance (this is the very basis of momentum strategies). Take gold, for example.
Fund flows have a near perfect correlation with performance.
Flows into gold funds is nothing compared to what happened in thematic funds.
If investors were rational, flows would be predictable. However, that is not nearly the case.
The problem with lumpy flows in to hot assets is that once the price action cools down, the funds are trapped. Investors tend to feel the emotional pain of a loss about twice as intensely as the joy of an equivalent gain. So, they wait for the next cycle to exit.
If you look the cumulative flows into Sectoral/Thematic funds, there’s a large reservoir of capital that will look for an exit when these funds come back up to par.
Flows follow performance. And if the asset is illiquid enough, performance will then overshoot flows to form a spiral.
Map the terrain. Understand the landscape before making your move.
Code and charts on github.