Home>Video>Bond Fund Flows Show Signs of Slowing Down

Bond Fund Flows Show Signs of Slowing Down

Thu, 14 Jun 2012

As economic concerns weighed, taxable-bond funds were the strongest asset gainers in May, but their inflows were only about half what they were the prior month, says Morningstar's Kevin McDevitt.

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Video Transcript

Christine Benz: Hi, I'm Christine Benz for Morningstar.

Asset flows into bond mutual funds had been a bright spot in the mutual fund landscape, but even they have been showing signs of slowing down.

Joining me to share some insights on the latest news in terms of mutual fund inflows and outflows is Kevin McDevitt--he is editorial director with Morningstar.

Kevin, thank you so much for joining me.

Kevin McDevitt: Thanks for having me, Christine.

Benz: Kevin, let's start with fixed income. We have been talking about how investors have been sending assets to bond mutual funds for several months running. But you say that in the month of May, they have shown signs of slowing down?

McDevitt: Right. You did see still, overall, taxable-bond funds were the strongest asset class by themselves. They had about $14.7 billion in inflows--and that's combining open-end funds and ETFs--but that's only about half or so what we saw the prior month. So, relative to what we've seen over the last few years, that's quite a slowdown in terms of the trend.

Benz: Kevin, I know it may be hard to generalize about why investors are doing what they are doing, but can you talk about what may have driven some of this recent action going on with bond funds?

McDevitt: Well, within taxable bond funds, it seemed like there was a bit of a flight to safety. You actually saw outflows out of high-yield bond funds, which had been one of the strongest areas over the last 12 months or so. If you look at both open-end funds and ETFs, you actually saw $2.8 billion in outflows; in the prior month you saw $2.5 billion in inflows.

And the other really popular category, intermediate-term bond funds, also saw a big decline in inflows. Combined, open-end funds and ETFs had about $3.7 billion in inflows; that's down from $7.2 billion the prior month.

And I think with all that's happening in Europe right now and concerns about slower growth in the U.S., it seemed like investors in general were just more focused on safety.

You saw strong flows into short-term bond funds. You had about $3.4 billion going into those funds. And ... for the first time certainly this year and really in quite some time, you saw strong flows into government-bond funds across the spectrum, from short-, intermediate-term, and long-term, you saw greater flows into those three categories than you have all year, and really just about over the last 12 months.

A lot of that owed, I think, to the fact that you saw interest rates, the yields, just plummet in May. You had the 10-year Treasury go from 1.96% to about 1.47%, a drop of about 50 basis points. So, a huge plummet, and again, somewhat of a flight to safety, I think, given all the macro headwinds out there.

Benz: And you note, Kevin, that some of these trends persist even when you aggregate flows into mutual funds and exchange-traded funds together. You're seeing some of the same preferences in terms of where investors are putting their dollars.

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McDevitt: That was certainly true on the taxable-bond side. You ... saw a real alignment there in terms of investor preferences.

There were areas, though, there were other categories, where that was not as much the case. And you saw that primarily with international stock funds, especially when it comes to emerging-market stock funds. There, on the ETF side, you actually saw pretty strong outflows out of the category. The iShares MSCI Emerging Markets ETF had about $1.5 billion in outflows, versus on the open-end side, you still saw strong inflows for the category overall--I believe about $1.8 billion. So, again, a real divergence--$1.8 billion going into open-end EM funds, versus about $2.3 billion in total outflows for ETFs.

Benz: So, let's talk about the equity fund universe. We have continued to see tepid flows, or even outflows, from equity funds. I'm wondering if you can talk about whether there have been any bright spots within that space?

McDevitt: As you mentioned, just to get it on the record, you did see another month of outflows for U.S. stock funds. On the open-end side at least, this was the 13th consecutive month of outflows for U.S. stock funds.

What was kind of curious, though, was that you actually saw a decline in outflows; even though the S&P fell about 6% in May, the level of outflows dropped a bit. We had about $9.3 billion in outflows in April, and only about $4.7 billion in May for open-end funds. If you throw in ETFs, it was about $5.2 billion in outflows.

But as you mentioned, one of the bright spots has been equity-income funds, and these tend to be more dividend-focused equity funds, and really the strong flows have been into actively managed open-end [equity-income] funds. Over the last 12 months, we've had about $21.2 billion going to these actively managed, equity-income funds. If you throw in ETFs, that adds about another $6.2 billion.

I think the interest really stems from the fact that these funds do have decent yields, even relative to bond funds, and also to some extent, given that they are investing in dividend-paying companies, it could be argued that they are investing in more stable, financially strong, large-cap companies, which are perhaps a safer way to access the equity markets, certainly if you are a risk-averse investor.

Benz: You can certainly see where investors are coming from in terms of preferring some of these equity-income funds. I am wondering if you care to opine about whether investors are maybe not paying attention to some of the risks by venturing into these funds, or maybe underplaying the risks.

McDevitt: As we've talked about in the past, given that [these funds] do have this dividend focus--they can be fairly concentrated in just a handful [or] a couple of sectors. They can tend to be focused on more dividend-oriented areas like utilities, telecom stocks. So there is more sector concentration, perhaps, there than you would see in other diversified stock funds. And really, this has become a very popular area for dividend-paying stocks. Also we mentioned REITs, things like MLPs, things which tend to be more dividend-focused, have attracted a lot of investor attention. So, there is a risk in terms of valuations there that they are getting a bit lofty, and there are some price risks there, perhaps greater price risk even than the broader market.

So, investors need to pay attention to that and realize there are a lot of people of the same mind when it comes to dividend-paying stocks, and that could be a concern.

Benz: Now, let's segue into international. There have obviously been a lot of scary headlines coming out from overseas--Europe's problems, obviously, but also concerns over slowing growth in China and India and some of the other markets. Let's talk about how that has manifested itself in terms of fund flows.

McDevitt: As I mentioned, it was interesting to see a real divergence between what we saw in the open-end and the ETF side. Surprisingly, perhaps, even though there has been a lot of volatility and that was certainly the case in May, on the open-end side, you still see investors putting money into diversified emerging-market stock funds; we had about $1.8 billion go into those funds last month.

What I think is interesting, though, is, on both the ETF side and the open-end side, you are seeing outflows out of the regional emerging-market stock funds--that is, things like Latin America funds, China region funds, India funds. Those more targeted areas have been seeing outflows, and for quite some time, and that really picked up last month. It's arguable that those are considered more trading vehicles for investors, and are maybe a better measure of more immediate investor sentiment versus on the open-end side in particular, diversified emerging-market funds are maybe more long-term money, but I am still surprised at how sticky that money has been and how consistently investors have been putting money there.

More broadly speaking, even with all the volatility, you did see reasonably strong flows into the core foreign large-cap stock funds on the open-end side. That was not as much the case, again, with ETFs. But you did see, again, with all the headwinds, it's somewhat surprising that there were decent flows into those core foreign stock funds.

Benz: Maybe some contrarian buyers out there, who knows.

Last thing I'd like to cover with you, Kevin, is what we are seeing in terms of fund families. You mentioned that MFS has recently jumped up in the rankings, and I am wondering if you can talk about which funds in particular have been driving that increase in popularity.

McDevitt: MFS had a strong month. It is driven really by two of their funds. MFS Value, a large-value fund, which has had strong performance recently, actually on the backs of two very dividend-oriented stocks: Philip Morris and AT&T have both had strong performance for the year, and have really helped the fund's performance year-to-date.

And then also their emerging-markets debt fund--which is their strong performer for years--had about $500 million or so in inflows in May. Between those two funds, that really pushed the family ahead.

But the real clear winner, and this is nothing new really, has been Vanguard. If you combine its inflows on both the open-end side and the ETF side, the family had inflows of well over $11 billion, about $11.3 billion in combined inflows.

Benz: And that's in a one-month period?

McDevitt: Right. It's just a one-month period, and also the fact that no one else is even close. The next closest family was JPMorgan with about $2.75 billion in inflows.

Benz: OK. Pretty striking numbers there, Kevin. Thank you so much for sharing your insights. We always appreciate hearing from you.

McDevitt: Thank you, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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