Investor Flows – The Everything Rally Becomes the Longest on Record

The everything rally continues after investors shifted beginning in March 2021 from higher to lower beta investments. Risk assets have commanded nearly 70% of all in-flows over the past month, a theme in place since Biden’s election in November 2020. 

Most notably, cyclicals and small caps are finally beginning to see in-flows return after long hiatus.

Investors habitually revert flows back into riskier investments including emerging markets, high yield corporates, and small caps from September into year-end. Could a similar cycle be underway in 2021?

The gap between flows for cyclicals and defensives is quickly closing after reaching an extreme early this month. As we have suggested, swift mean reversion seems highly likely.

Bigger picture, investors could really do no wrong with nearly all asset classes producing very favorable risk-adjusted returns. In fact, the average Sharpe ratio across the range of assets has persisted above 1-to-1 for a record 270 trading days!

A favorite chart of ours over the past two weeks has been of tightly huddled together Sharpe ratios. Their range is on par with only two periods in history, which both occurred ahead of tightening cycles.

Since March 2021 investors had greatly dampened flows into sector-specific funds, instead opting for more diversified large cap and index funds. However investors have steadily been returning to health care, technology, and now financials.

Demand for foreign exposure persists, led by APAC and the eurozone. Latin America remains the odd man out.

Investors’ previously insatiable thirst for inflation-friendly assets has thus far failed to return. TIPS remain in demand at a pace of $0.87 billion per week, but commodities, materials, industrials, and energy continue to see out-flows. 

Inflation protection ETFs (TIPS) may be near all-time high in-flows, but nominals have begun to quickly give chase. The spread rolling one-year flows into TIPS and nominal US Treasuries with maturities greater than two years seemingly peaked in late July 2021. The revival of flows into nominals relative to TIPS has typically been a leading indicator of inflation expectations overall.

Remember investors routinely pull assets from TIPS funds beginning in late August. Seasonal tailwinds across commodities and inflation data releases come to an end and become headwinds moving into year-end. Inflation data releases must persist at elevated levels to keep similar flows from occurring in 2021.

Governments, namely US Treasuries, have seen mild demand since mid-June 2021. Long-end maturities continue to gain the most interest, hence the flatter yield curve.

Lastly, aggregate bond funds remain the top dog among fixed-income funds, taking in $7.4 billion over the past month. Investment grade corporates are finally seeing steadily improving demand at a pace of $3.5 billion. High yield corporates have yet to see strong flows either way.

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