By Ben Baden

Investors can learn a lot from looking at which funds fellow market participants are flooding into or shunning. Each week, a number of different organizations, including the Investment Company Institute (ICI), issue an assessment of the previous week's fund flows. By analyzing trends in fund flows -- which measure the amount of money entering and exiting different types of funds -- investors can sometimes glean which asset classes are overheating or unloved.

To put it simply: "Fund flows are the ultimate driver of asset values globally," says Brad Durham, managing director of EPFR Global, a firm the specializes in tracking global fund flows.

Typically, fund flows show investors what they're already seeing in the broader markets.

"For example, if the stock market is heading south, you'll often see outflows in stock funds and vice versa," says Sean Collins, senior economist at ICI. Fund flows can also be a measure of investor sentiment. Recently, they offered insight into investors' concerns about the budgets of some state and local governments. Since November 2010, investors have pulled about $39 billion from municipal bond funds. (At the same time, they've poured almost $30 billion into taxable bond funds.)

Fund flows also reveal trends over longer periods of time.

For instance, following 2008's financial crisis, investors piled into the perceived safety of bond funds and moved away from the volatility in stock funds. From the beginning of 2008 through the end of 2010, mutual fund investors pulled more than $272 billion from U.S. stock funds and poured almost $650 billion into bond funds, according to ICI. (To put those numbers into perspective, at the end of 2010, U.S. stock funds held approximately $4 trillion in assets, and bond funds held $2.6 trillion.) Despite the bull market that started in March 2009, only recently have investors begun moving back into U.S. stock funds.

If you break down flows by different types of investors, other trends begin to take shape. For example, compare ordinary retail investors with institutional investors, such as hedge funds and pension plans, and you'll see that they have approached the market in very different ways. Examining fund flows from the market's bottom in March 2009 to present -- during which the S&P 500 has almost doubled -- it seems as if "the rally, if you just look at U.S. equities, was driven almost exclusively by institutions," Durham says. During that time period, institutional investors have plowed about $174 billion into U.S. stock funds, according to EPFR Global, while retail investors have pulled about $224 billion from U.S. stock funds.

This illustrates a common theme in investing:

Time and again, retail investors jump into stocks only after they've rallied. "It's unfortunate because people tend to miss the best performance because they're too scared," says Jeff Tjornehoj, senior analyst at Lipper. "When you see the market taking a dive, that's the time when you really want to be thinking about buying more, because that's the low point."

Durham says many of EPFR Global's institutional clients use its fund-flow data to look for trading opportunities. If they see excessive inflows into one asset class, they may decide it has become overheated and is due for a sell-off, or vice versa. The latest sell-off has been in emerging markets stock funds. Last year, inflows into this asset class set a record of $95 billion, according to EPFR. But amid inflation concerns and unrest in the Middle East and North Africa , investors have retreated somewhat. So far this year, emerging markets stock funds have seen outflows of about $19 billion, according to EPFR.

The rise of ETFs has also been documented in fund flows.

Late last year, net assets for ETFs topped the $1 trillion mark. That's still about $7 trillion less than the net assets of mutual funds, according to Morningstar. But the amount of money flowing into ETFs is steadily increasing. "It's grown tremendously, and I think it's where much of the flow activity is taking place these days," Durham says.

Durham says inflows and outflows in ETFs are becoming more important to market watchers because investors use them to invest in specific regions of the world as well as narrow asset classes. "[ETFs] also allow investors to express much more quickly their changing sentiment," he says.


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