In 2005 Andrea Frazzini and Owen Lamont from Yale University published a preliminary research paper simply titled "Dumb money: Mutual fund flows and the cross-section of stock returns". This was their conclusion:
"In this paper, we have shown that individual investors have a striking ability to do the wrong thing. They send their money to mutual funds which own stocks that do poorly over the subsequent years. Individual investors are dumb money, and one can use their mutual fund reallocation decisions to predict future stock returns."
I can attest to this conclusion myself having personally witnessed it happen time and time again throughout my history in the investment management business. In the early years, financial professionals could save a few from becoming part of the "dumb money". However, with the overwhelming acceptance of 401K's, the movement towards Self-Directed Retirement accounts, and the commission incentive that has driven many financial advisors towards the "sell your client what they want, not what they need" approach, the amount of the "dumb money" has continuously been increasing.
Given that, let's take a look at mutual funds and where the current "dumb money" is flowing. Last week a report released by Emerging Portfolio Fund Research Inc., stated that emerging-market equity funds had inflows of $3.5 billion for the one-week period ending May 13, surpassing U.S. equity funds which took in $2.6 billion. This is quite amazing when you consider the fact that the U.S. equity market is 15 times as large as the emerging markets.
Emerging markets are not the only place where a lot of "dumb money" is flowing. The U.S. bond market has had a total of $19 Billion in new investments this year with high-yield, or should I say junk bonds, being the most popular.
What about the "smart money"? Last week the Greater Orlando Aviation Authority, a smart money institutional investor, made the decision to transition its assets from mutual funds to separate accounts managed by professionals for two very important reasons. They wanted to increase transparency and lower cost.
The Massachusetts Water Resources Authority Retirement System, another "smart money" institutional investor, is seeking a professional separate account manager to oversee and increase the amount of funds they have allocated to large and powerful US Corporation. Although they didn't share their reason, their actions speak for themselves.
If Dr. Frazzini and Dr. Lamont's research is correct, then by all means stay away from emerging market and bond mutual funds. If there is "smart money" we strongly suggest that you follow the lead of the Orlando Aviation Authority, the Massachusetts Water Resources Authority and of course that of Anderson Griggs Portfolio Management.
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