Mutual Fund Cash Flows and Stock Market Performance* During the decade from the 1990s through 2001 there were some important changes in the distribution of investment assets . By a number of measures, mutual funds have grown significantly as vehicles for investing in stock portfolios. Specifically, net cash flows to equity funds grew from $13 billion in 1990 to $310 billion in 2000.1 During the same period, the number of equity funds increased from 1,100 to 4,395, while the number of accounts in these funds increased from 22 million to 162 million. . The cumulative effect of new money pumped into stock funds, along with the reinvestment of dividends, plus the resulting stock price appreciation, has produced phenomenal growth in total net worth. The market value of these assets rose from $239 billion in 1990 to $3,962 billion in 2000. Assuming that funds have become major players in stock markets, how important is their influence relative to other factors that determine performance of the market? Trade press and business news typically focus their attention on earnings growth, interest rate movements and other relevant financial and economic indicators. However, there is very little in the professional and academic investment literature that compares the impact of mutual fund cash flows with the variables mentioned above. The purpose of this study is to provide a focus, comparison and perspective on the importance of mutual fund flows. It presents evidence that mutual fund flows can be a very significant factor in explaining monthly movements in stock market returns and provides some estimates of how large the impact might be. Specification of Variables and Causal Relationships The basic model used in our study includes other important factors and liquidity variables in addition to mutual fund flows. The model specifies that the stock market return is a function of net flows into equity mutual funds, the growth rate of the M2 money supply, changes in the federal funds rate, and growth in earnings per share. This study recognizes and acknowledges that money movements in the stock market through mutual funds are related to the overall business conditions. Clearly, company earnings and revenues and the external economic environment in which businesses operate will influence investor decisions. However, the link between company performance and committing money to stocks is not rigid. In the short term and even over extended periods of time, masses of investors may be plagued by “irrational exuberance” or may fall down a “wall of worry””.”.