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By Christine Benz and Michael Rawson, CFA | 06-17-2013 11:00 AM

Rising-Rate Concerns Push Investors to Noncore Assets

May flows data show investors are putting money to work in nontraditional fixed-income holdings, as well as emerging-markets equities, for perceived better returns.

Christine Benz: Hi, I am Christine Benz for Morningstar. Investors were buying bond funds again in the month of May, but their choices indicate a growing caution about the prospect of rising interest rates. Joining me to discuss the latest in fund flows is Michael Rawson. He is a fund analyst with Morningstar.

Mike, thank you so much for being here.

Mike Rawson: Thanks for having me, Christine.

Benz: Mike, the month of May was actually a good month for bond-fund flows, even though it wasn’t a great month for bond-fund performance. Let's talk about what investors were actually buying during the month.

Rawson: Well last year, going back to 2012, we saw very strong flows into the core intermediate-term bond category. People were plugging money away into bond funds. So far this year, particularly in the last few months, investors have been skeptical about that intermediate-term bond category and I think cautious about the prospect of the Fed tapering the quantitative easing measures. So what have gained assets recently are bank loans and nontraditional bond funds. Investors have really stopped adding to the intermediate-term core bond funds.

Benz: And you also noted that government-bond funds have been a weak pocket, too, because I think investors perceive them as perhaps especially rate-sensitive.

Rawson: Absolutely. I mean all you're getting there is interest-rate return. You're not getting the spread from potential improvements in credit. You have fixed interest rates; you don’t have the floating rate that the bank loans offer. So people have been very skeptical about adding money into these straight, traditional, safe core bond funds, government-bond funds. I say "safe" because they're safe if interest rates are in a flat or down-trending environment. These other nontraditional categories would be considered riskier. But they're going to hold up better when interest rates rise, and in fact they did last month. So last month the PIMCO Total Return mutual fund fell about 2%. The PIMCO Unconstrained fund fell only about 0.5%. So it held up a lot better.

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