In this special episode, EPFR Quantitative Researcher Azalea Micottis joins Director of Research Cameron Brandt to discuss her latest insight on Japan and retail flows. They reflect on a recently published Off the Wire piece looking at the flows coming out of Bond Funds dedicated to long-term Japanese government bonds. To hear about several of EPFR's quantitative strategies and the signals those strategies are generating, listen to the full episode!
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Hello there! This is Cameron Brandt Director of Research at EPFR with our weekly podcast where we update you on some of the trends and changes that we're seeing in our weekly flows and allocations data. Our usual collaborator Kirsten Longbottom is off soaking up the Mexican sun this weekend but I am joined by one of our rising quant stars from London Azalea Micottis. Azalea, thank you for joining us. Did you have to navigate any picket lines to make it in today?
Fortunately not and I'm actually working from home. So no strikes for me today or this weekend. So yeah, thanks for having me cam.
You're welcome. So a week that was definitely a bit different from the somewhat optimistic pattern of flows that we saw for much of January. It certainly seemed as if investors were finding it a little harder to maintain their rosy views of where US interest rates are heading and the Chinese economy is going to bounce to as the US and China snapped and snarled over a pick your choice of spy balloon or stray weather balloon getting shot down off the Carolinas. Certainly injected a reminder to investors that despite some less aggressive remarks in recent weeks the US and China are not on the same page in many areas and that will have economic implications. Among the other fund groups that are among the fund groups that took a bit of a hit this week where US equity funds and Japanese Equity Funds and we also saw Europe Equity Funds recent run of inflows come to a halt. Not that's surprising given the ECB's recent 50 basis point hike and their assertion that another one is coming in March and the slow painful gains but gains nevertheless that Russia's latest offensive on the Donbas part of Ukraine is achieving. I was again somewhat interested in the Japan flows. There is obviously a growing sense that a monetary policy framework that's been in place since 2013/2014, an ultra-commodative one is not going to survive in its current form much beyond the second quarter of this year and that tighter monetary policy is very likely in the second half of 2023.You know that obviously has some implications for the Japanese Yen and Azalea I know you've been sort of doing some quant research and modeling in that area. What have you been seeing?
Yeah, so I guess on the Japan side before we launch into anything kind of too complex I mean definitely as you've mentioned the the outflows from both Japan Equity and Japan Bond Funds are something that we've seen in our data this year. Also one piece that we published relatively recently looked at specifically the flows coming out of Japanese Bond Funds focusing on Long-Term Government Bonds. And really that has been a space where there's been a lot of long-term outflow, especially when bond yields in Japan rose above 50 basis points in December. So in addition to the kind of flows data that we can see, what our team also does is, we've built a number of kind of signals or data that can look at different aspects to what's going on in different countries and also directly what's happening to the Yen which obviously did take quite the toll after all of the different things that have been happening in Japan recently. So one signal that we look at and we work with quite often is our Daily FX flow signal. So it looks at the flow into different currencies based on flows that are going into - this time - cross-border funds, and specifically those with an equity mandate. And actually interestingly what we've seen here is this signal towards the Japanese Yen has produced inflows year-to-date. So the opposite to what we've actually seen within the the Japan focused Equity Funds space. And in fact, the kind of last month or so of 2022 we actually saw outflows so it seems like there's been some sort of reversal at least over the last couple of months.
Is it your sense that certainly fund managers are starting to position themselves for a stronger yen?
If we are looking at it from this perspective, possibly yes, so I guess this kind of ties back into to what you were saying previously about a possible reversal or change in the monetary policy later this year. And what we have also seen, again just to tie into what i've mentioned about our daily flows into the yen, another signal that we've calculated this time from our FX Allocation data, which looks at the positions of Equity and Bond funds towards currencies such as the Yen is that here, this time looking instead at the Active versus Passive managers relative allocations towards a currency, again this time the Yen, is that throughout last year about 20% of Active managers relative to their Passive kind of cousins or benchmarks we could call them, were overweight the currency and actually towards the end of this year this increased quite sharply. So again, they're increasing their allocations towards that that currency towards the Yen, so it went up from about 20% to to about 35.
Well, that's a pretty significant jump. So in addition to Japan and the Yen, there's China and the Ren Minbi, we saw both China Equity and Bond Funds post solid outflows this past week which is certainly not the- certainly on the equity side- not the pattern we've been seeing recently as I said when we kicked off this podcast. The reminder that US-Sino tensions haven't gone away I think definitely served as a bit of a reality check for investors. And while I'm certainly comfortable with the proposition that there's going to be a notable pickup in chinese economic activity in the second half of the year, it's a market that still has some fairly major headwinds to sort out. The property sector is still under pressure, the aftershocks from Covid escaping the containment of the zero-Covid policies are likely to ripple through and keep chinese consumers a little less ebullient than maybe some people are penciling in. One thing I was interested in this week too is that even though there's considerable uncertainty surrounding the monetary policy picture and whether it's going to have to go further to contain inflation and by doing that increase the risks of a sharp recession, it wasn't a risk-off week in the sense that High Yield Bond Funds, Emerging Markets Bond Funds, Alternative Funds all managed to take in some fresh money during the week and Frontier Markets Equity Funds which are geared to the most risky segment of the emerging markets universe also took in some fresh cash. The redemptions from US Equity Funds were notable for a couple of reasons. One is that they were the fourth out of the six weeks year-to-date and come when the key US indexes aren't doing so badly. The latest week also saw a sharp jump again in the redemptions from US Equity Retail share classes. Historically and especially on the institutional side, retail flows have been viewed as something of a contrarian indicator but Azalea you've done a little bit of digging into what retail flow means, I think you have a slightly different perspective.
Yeah that's right I mean at least from I guess more of a systematic view. As you mentioned the general consensus is that retail flows are generally considered to be more of a kind of dumb money indicator. But the work that we've done which ties in with kind of again building signals from our data and kind of back testing that but here using only the flows into retail share classes, whether that's building a signal from a country perspective, an equity regional perspective, a sectoral perspective and also in a multi-asset setting. What we did find is that the results that we got from these back tests especially compared with some of the oldest strategies that we've created and used traditionally,the results have actually improved. Especially what we've seen is that in the last few years, maybe from 2013 onwards and if we look at a country rotation for example with an aque using explicitly only retail share class flows has produced much better sharp ratios and much better annual returns. So that was quite interesting to see especially given the general thoughts about this type of investor. The one thing that we had tested that we found that retail share class flows did not work as well as our kind of traditional proof of concept strategies was in FX markets interestingly.
That is interesting. So perhaps I was a little quick to dump all those meme stocks. I'll wind up our conversation today by quickly running through the sector fund flows because we saw quite a bit of conviction in that area over the first week of February. I have to say a lot of the conviction was of the negative sort as investors digested what's been a pretty mixed earnings season with even the better earnings reports often being accompanied by guidance that's a lot less bullish than the numbers might suggest. But we are seeing a rebound in interest into Financial Sector Funds. The latest weeks flows were the highest in 24 weeks and their latest inflow run is the longest since the third quarter of last year. And flows into technology sector funds also have bounced back in the latest week. It seems that investors are actually encouraged by the somewhat painful job culls going on in the US sector and intrigued by what all the talk about to the chat gbt applications might mean for the profitability and value of some of the big names. With that I think I'll sign off. Thank you Azalea for accompanying me on this week's journey and I look forward to having you back with us again on a future date.
With pleasure. Thank you Cam.
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