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Our Chief Global Cross-Asset Strategist, Serena Tang, explains where funds are moving across global markets currently, and why it matters to investors.

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Welcome to Thoughts on the Market. I\u2019m Serena Tang, Morgan Stanley\u2019s Chief Cross-Asset Strategist. Along with my colleagues bringing you a variety of perspectives, today I\u2019ll dig into the concept of fund flows, how they shape global markets and why they matter to investors. 

It\u2019s Thursday, August 1, at 10am in New York. 

Finance industry professionals often use the term \u201cflows\u201d when looking at where investors are, in the aggregate, moving their money. It refers to net movements of cash in and out of investment vehicles such as mutual funds and exchange-traded funds, or in and out of whole markets. By looking at flows, investors can get a good sense of where market winds are blowing and, essentially, where demand is at any given moment. Now, whether you\u2019re a retail or institutional investor, having a perspective on market sentiment and demand are powerful tools. So today I\u2019m going to give you a snapshot of some key flows, which should give a sense of demand and the mood right now; and what it means for investors.

First of all, despite the recent rally in global equities year-to-date, we've yet to see an investor rotation, or portfolio realignment, from bonds to stocks. Flows into bonds are still leading flows into stocks by a pretty large margin. And unless stocks cheapen materially, we don\u2019t expect this trend to reverse anytime soon. In addition, fund flows into large-cap equities still dwarf those into small-caps year-to-date. Although we saw a brief reversal of this trend in June, large caps flows have swung back to prominence. 

We do see hints of sector rotation within equities, as investors shift to what they see as more promising stocks; but it\u2019s not a clean or entirely unambiguous story. The Science & Tech sectors \u2013 which saw a notable drop-off in flows from the first to the second quarter of this year \u2013 still lead year-to-date; and flows represent nearly a third into all flows into equities. More cyclical sectors like Basic Materials and Financials attracted more capital than in the first and second quarter, while defensive sectors such as Consumer Goods saw a softening of outflows compared to the same period. 

From a global perspective, we also look at flows in and out of particular regions or markets. So, year-to-date, US stocks received about US$43 billion in net inflows while rest-of-world stocks saw about US$15 billion in net outflows. Now, there were some exceptions \u2013 with India, Korea, and Taiwan leading \u2013 seeing significant inflows year-to-date. 

We look at flows within categories too, so within fixed income, for example, we are seeing flows toward less risky assets; revealing what we call a risk-off preference. Higher quality, Investment Grade funds \u2013 raked in about US$92 billion in net inflows year-to-date, while US treasuries saw only at US$25 billion. That Treasury number is actually significantly higher than what we saw from the first quarter to the second quarter, while inflows to High Yield and low-quality Investment Grade corporates have slowed compared to the start of the year. 

Finally, money market funds \u2013 that is mutual funds that invest in short-term higher quality securities \u2013 have not yet really seen sustained outflows, as one would expect when investors believe shorter term yields would come down, as central banks start to ease. Rather there\u2019s been some $70 billion in net inflows through the first half of this year. Although we\u2019re sympathetic to the view that money market outflows should begin when the Fed starts cutting rates, there\u2019s actually a considerable lag between first cut and those outflows, as we have seen in the last two rate cutting cycles. 

But what does all of this mean for investors? Well, it suggests they still have a defensive tilt, and they shouldn\u2019t really be jumping on the rotational story. The current yield environment means rotation from fixed income and money market funds into riskier assets is still some way away. Investors also shouldn\u2019t look at the dry powder/cash on the sidelines narrative as the big tailwind for riskier assets -- because it\u2019s not coming any time soon. That said, we still like non-government bonds because this is where cash would go first if and when those flows begin. We also like global equities, but more so because the benign macro backdrop we are forecasting supports this. 

We\u2019ll keep you up to date if there\u2019s any change in the direction of market winds and fund flows.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.