Investors withdrew a net $22.9 billion from U.S. stock funds in July, the greatest level of net redemptions since investors pulled $27.9 billion during the credit crisis’ peak in October 2008. Given equity markets’ incredible volatility and deep dive so far this month, equity outflows will undoubtedly soar in August.
In other words, investors are almost as freaked out now as they were when the world really was about to end. In between October 2008 and now, we’ve seen huge stock market returns driven by incredibly good corporate profits—and still investors are very reluctant to step up to the plate with equities.
Ironically, this is probably a very good sign for stocks going forward. We’ve written before about Morningstar’s own “Buy the Unloved” strategy:
Since 1994, Morningstar has been tracking a strategy of buying the asset classes that had the largest net outflows and then holding the positions for three years before rotating them out. The essential idea is just to buy an asset class when it is out of favor and hold on to it patiently, long enough to reap the gains. In effect, this is simply doing the opposite of what most investors do. The strategy produces better than market returns over both three-year and five-year time horizons.
From 1994 through 2009, the buy-the-unloved strategy produced an annualized 8.1% return, compared with 4.77% for the loved, 6.24% for the S&P; 500, 6.96% for the Wilshire 5000, and 5.36% for the MSCI World. This assumes you invest in the unloved categories for three years running and then roll over the oldest group into the new unloved group starting in year four.
The strategy also produced strong results if you run it on a five-year rotation. In that version, the unloved produced an 8.08% annualized return, compared with 4.25% for the loved, 5.17% for the S&P; 500, 5.76% for the Wilshire 5000, and 4.55% for the MSCI World.
By the way, going against investor sentiment has a long track record of profitability well before Morningstar started following it in 1994. Disenchanted investors withdrew money from equity funds for most of a decade following the 1973-74 bear market—just in time to miss out on a 16-year bull market starting in 1982.
The timing may never be very precise, but looking seriously at asset classes that others are avoiding is often a recipe for investment success.
It’s not easy to be the contrarian though. The media focuses on fear/love (momentum driven) and there’s always that push/pull investors feel between being dispassionate value investors vs. riding/jumping on and off short term trends.
i’m confused. since when do momentum/relative strength guys want to buy the unloved strategy/ market?
We’ve written some articles on this before-there’s a big difference in buying a stock on a dip and buying a strategy on a dip. It makes sense to add to your strategy when it’s out of favor. In a portfolio construction context, where you might have many different asset classes in the mix, it is usually a good idea to add on weakness. We regularly run a High RS Diffusion Index on the blog to identify good times to add to our particular strategy.
[…] ICI data that we highlight each week shows large capital flows out of domestic equities, and Morningstar demonstrates quite convincingly that it is possible to outperform just by purchasing what everyone else is throwing […]