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Fund Flows: Investors Turn on Bond Funds

Long-term flows go negative; muni-bond funds suffer record outflows.

Kevin McDevitt, 01/25/2011

Bond funds fell further out of investor favor in December. There were an estimated $10.6 billion in long-term outflows in December, most of which came from fixed-income offerings. This follows modest $5.1 billion long-term inflows the previous month. This is the first time since May 2010 that long-term flows have been negative. Money market funds also experienced outflows of $2.2 billion, which owed to $7.3 billion leaving taxable vehicles. Tax-free money market funds, on the other hand, collected $5.1 billion.

Redemptions in municipal-bond funds soared to a record $13.4 billion in December, which builds on the previous month's $7.6 billion in outflows. More on this subject follows below, but note that the past two months of combined outflows represent roughly 4.4% of current municipal-bond fund assets.

Although not nearly as cataclysmic, taxable-bond flows also turned negative in December for the first time in more than two years, as funds shed nearly $4.5 billion. This was the first time since November 2008, when the credit crisis was still in full roar, that money left taxable-bond funds. While negative flows are new, the trends within the asset class are not. As we have pointed out in past commentaries, flows into short- and intermediate-term bond funds have been declining since September 2009.

Alternatively, investors seem to be slowly warming to equity funds. U.S. stock funds still shed about $7.6 billion in assets in December, though, marking the eighth consecutive month of outflows (this despite the S&P 500 index's 15.2% return in 2010). But the pace has slowed considerably, especially considering that most of this past month's outflows stemmed from a shift in asset allocation for Vanguard's target-date funds and several fund of funds.

Vanguard announced this past September that it would increase the international equity allocation in these funds to 30% from 20%. That change hit fund flows in December as Vanguard Total Stock Market Index VTSMX showed outflows of roughly $7 billion, while Vanguard Total International Stock Index VGTSX recorded inflows of more than $8 billion.

If these exchanges are stripped out (as they do not reflect new investor contributions or redemptions), then U.S. equity funds would have lost less than $1 billion in December. This would mark the smallest level of outflows during the past eight months. Meanwhile, international stock funds would have taken in a net $2.9 billion--most of which went into emerging-market funds--after subtracting the Total International Stock Index inflows. Even with this adjustment, international stock funds have now enjoyed four consecutive months of inflows.

Taxable Bond
Within the taxable-bond universe, most of the damage in December hit the two largest categories: short-term and intermediate-term funds. Short-term bond funds lost $1.4 billion, while intermediate-bond funds shed more than $8 billion. We estimate that $241 billion PIMCO Total Return PTTDX endured redemptions equal to approximately 3% of total assets. This follows the fund's roughly $2 billion in November outflows. Perhaps some investors are starting to agree with Bill Gross that future bond returns don't look terribly attractive.

Keep in mind, though, the impact of rising interest rates. The yield on the 10-year Treasury has spiked about 100 basis points since early October. Intermediate-term bond funds dropped nearly 0.8% on average in December alone.

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