Record Outflows (EP.63)

Episode Summary

Executive Summary: The episode reviews 2018’s market turmoil through fund-flow data, arguing that bear markets may accelerate the shift from active to passive investing rather than reverse it. The hosts discuss weak active-manager performance, industry liquidations, valuation reset, behavioral biases, and why timing the economy or market is notoriously difficult. They also cover credit-card rewards, gender in asset management, millennial optimism, and personal finance/media recommendations.

Main Topics: Market outflows and the rise of passive investing (Priority: 5/5): They open with record equity outflows and November data showing money leaving active funds while flowing into passive funds, arguing that downturns may accelerate passive adoption rather than undermine it. Active manager blowups and industry consolidation (Priority: 5/5): Northern Cross’s liquidation and David Einhorn’s poor 2018 are used as examples of how underperformance and outflows can force closures, especially if a bear market becomes prolonged. Factor investing, S&P dominance, and mean reversion (Priority: 4/5): The hosts note that multi-factor ETFs generally lagged SPY in 2018, while the S&P continued to dominate small caps, value, and even many defensive strategies, raising the question of whether leadership must eventually rotate. Market timing, tactical funds, and behavioral pitfalls (Priority: 5/5): A seasonality/tactical mutual fund that aimed to move in and out of markets badly lagged buy-and-hold, reinforcing their view that timing is hard and risk management is often punished in bull markets. Economic indicators and the limits of forecasting (Priority: 4/5): They debate unemployment, payrolls, and other macro indicators, emphasizing that data are lagging, hard to compare across historical regimes, and unreliable for precise market timing. Valuation, dividend yields, and equity risk premium (Priority: 4/5): The conversation shifts to lower valuations and higher yields after the selloff, plus a model showing a high equity risk premium, suggesting stocks may now offer better forward returns. Consumer finance, surveys, and personal recommendations (Priority: 2/5): They discuss paycheck-to-paycheck surveys, millennial wealth expectations, credit-card reward economics, and end with book/TV/movie recommendations and a funny aside about Siri/FaceTime failure.

Key Arguments: Bear markets do not necessarily cause investors to flee index funds; they may instead speed up the exit from active funds, since investors often use downturns to abandon chronic underperformers. The S&P 500’s persistent outperformance is a major reason active management has struggled, and this leadership may continue unless market leadership rotates to a new concentrated set of winners. Timing strategies are extraordinarily difficult, and even rules-based tactical approaches can fail badly when markets remain resilient. Economic data like unemployment and payrolls are poor tools for calling turning points because they are lagging, revised, and hard to compare across different eras. A broad selloff can improve future expected returns by lowering valuations and raising dividend yields, making equities more attractive on a forward basis. Investors are often overconfident: millennials expect high wealth outcomes despite little retirement savings, and many individuals underestimate the difficulty of saving consistently. Credit-card reward systems are economically supported by interchange fees and interest charges, and issuers can change the value of points at any time.

Data Points: Record equity outflows: past six weeks - Bank of America Merrill Lynch chart discussed at the top of the episode Active fund outflows: $57 billion - Money pulled from actively managed funds in November Passive fund inflows: $56 billion - Money put into passive funds in the same November period Harbor International Fund AUM: from $40 billion to well under $10 billion - Decline in assets after underperformance and outflows Harbor International underperformance: -1,200 basis points - Five-year comparison versus MSCI EAFE; fund down 6.5% vs benchmark up 6% Multi-factor ETFs: Only 2 beat SPY in 2018 - Bloomberg tweet referenced during factor-investing discussion Tactical/seasonality fund performance: Just over 7% since 2014 - Compared with S&P 500 up 57% over the same period S&P 500 trailing dividend yield: 2.0% - Current yield discussed as having risen after the selloff Emerging markets trailing dividend yield: 2.7% - Yield comparison across global equity regions Pacific stocks trailing dividend yield: 3.0% - Yield comparison across global equity regions Europe trailing dividend yield: almost 4% - Highlighted as surprisingly high relative to U.S. stocks Calculated equity risk premium: close to 6% - Aswath Damodaran’s estimate, described as top-decile historically Historical years with comparable equity risk premium: 1979, 2009, 2011 - Years cited as the only other times with similarly high implied premium Job growth streak: 99 months - Record run of monthly employment gains cited from the New York Times Average monthly job gains in 2018: 220,000 - Urban Carmel data cited as strong labor-market evidence Annual employment growth rate: 1.8% year over year - Referenced alongside strong jobs data JP Morgan credit-card rewards accrued: $5.8 billion - Rewards earned but not yet redeemed by cardholders as of Q3 Increase in accrued rewards: 53% - Growth versus end of 2016 Merchant interchange fees: $43 billion - Visa and MasterCard interchange fees paid by merchants in 2017 Interchange fee growth: 68% - Increase versus 2012 High-income paycheck-to-paycheck rate: 25% - Families earning $150,000+ living paycheck to paycheck in Nielsen study Middle-income paycheck-to-paycheck rate: one in three - Families earning $50,000-$100,000 living paycheck to paycheck Lower-income paycheck-to-paycheck rate: 50% - Families earning under $50,000 living paycheck to paycheck Millennial wealth expectation: 65% - Millennials ages 22-37 expecting seven-figure wealth by age 45 or sooner Safe retirement savings among millennials: two-thirds have nothing saved - Contrast to their high wealth expectations Metropolitan Museum average viewing time: 32.5 seconds - Used in recommendation for the book 'Impossible to Ignore'

Pivotal Quotes: "If flows into index funds are distorting the market, how come flows out of active funds are not having any effects?" — Michael/Ben: Discussion of active versus passive flows and market impact "I think index funds are going to continue to see. .. I think they're going to make huge gains in terms of flows in a more extended bear market." — Michael: Prediction that downturns will accelerate passive adoption "I think it's really hard to do." — Ben: Repeated conclusion about timing the market and forecasting the economy

Implications: The episode suggests investors should expect continued passive-fund growth, more stress on active managers, and higher future equity returns after valuation resets. It also reinforces humility: macro timing, tactical shifts, and trend-chasing are far less reliable than steady saving and diversified ownership.