Fri, 16 Aug 2013
Investors appeared to be trading interest-rate risk for equity and credit risk in the wake of this summer's rate-driven bond volatility.
Christine Benz: Hi. I'm Christine Benz for Morningstar.com.
Investors appear to be trading interest rate risk for equity and credit risk in the month of July. Joining me to discuss the latest fund flow data is Michael Rawson. He is a fund analyst with Morningstar.
Mike, thank you so much for being here.
Michael Rawson: Thanks for having me, Christine.
Benz: Mike, I think it's interesting, when you look at fund flows for the month of July, you saw modest outflows from taxable fixed-income funds. But you say that there is a lot of action underneath the surface. Let's talk about some of the choices that investors are making, and specifically what they've been selling, especially since the interest rate shock we had in that period from May through early July.
Rawson: You mentioned that May through early-July period, and that's when interest rates really spiked up. We saw huge outflows, record outflows, from taxable-bond funds, the category group overall, particularly from intermediate-term core bond funds.
So over the last several weeks, in the month of July, we continued to see outflows from those categories, the safe categories--the categories which are traditionally seen as safer--intermediate bond, intermediate-term government bond, and long-term bond.
But we had inflows that offset those outflows. So on the surface, it looked like the flows to taxable bond had moderated, but it was investors trying to get away from interest-rate risk, and maybe taking on some more credit risk. So they went to bank-loan funds, they went to high-yield, and they went to nontraditional bond funds.
Benz: Let's drill into some of the categories that investors were selling. You noted in your recent report that the Ginnie Mae funds saw very large outflows. Let's talk about what's been going on in that group.
Rawson: The Ginnie Mae funds are mortgage-backed securities, which are backed by the government, so they don't have the credit risk, but what happens is, when interest rates rise, investors tend to prepay their mortgages less frequently. So these bonds extend in maturity, and it becomes a longer-duration type of instrument, and then it has more interest-rate risk right in an environment when interest rates are rising. We've seen strong outflows from that category for really several months, and then it was particularly bad the last two months, and that's a category where the returns have been less than the returns in the Barclays Aggregate Bond Index. Even though you don't have much credit risk there, in essence you're getting more interest-rate risk right when you don't want it.
Benz: So the intermediate-term bond funds also saw big outflows during the period, as well as the inflation-protected securities group. Let's talk about why investors seem to be shunning those two groups.
Rawson: The inflation-protected securities group is where people would go if they thought inflation was going to be higher than expected, and that's not the scenario that people are envisioning now. People are thinking that inflation is actually quite tame. So I think investors are moving out of the Treasury inflation-protected securities.
Those [TIPS] funds tend to have long duration--so people are moving away from those categories. They're also moving away from just the core bond funds, and in the intermediate-term bond category, we have PIMCO Total Return, and that fund suffered pretty large losses in July in terms of outflows.
Benz: So they have continued in the month of July.
Rawson: They have continued. This is the third straight month of outflows from PIMCO Total Return, and if you aggregate them, the outflows over the last several months are about equal to the inflows you had in all of 2012, in the beginning part of this year. So, it's pretty massive, quick outflows from PIMCO Total Return. Its performance actually bounced back a little bit in July. It was actually above the index. So I don't think it's a sign that investors are losing confidence with Bill Gross. It's just that they want to move away from the interest rate risk. At PIMCO, we saw inflows into PIMCO Unconstrained and other types of funds, which would be more defensive [against] rising interest rates.
Benz: I wanted to drill into this bank-loan group a little bit, Mike. $8 billion [flowed] into the category during the month of July, and then $39 billion year-to-date. That's a huge level of flows into a category that I think a lot of us thought was sort of a niche fixed-income category. Why have investors been liking those funds so much?
Rawson: Bank loans, and floating-rate loans in general, are loans where the interest rate risk is little bit less. You have lower duration, because the interest rate can reset on these loans. So the flows to these categories have been very strong really all year, and I think this is the strongest-flowing category so far this year because of [investors seeking] defensiveness from rising interest rates.
You also have some credit risk there, and people are embracing the credit risk aspect, because the economy is generally strong. So this seems to an ideal trade-off between wanting to avoid interest rate risk, but not wanting to take as much risk as you would get in the equity markets. So you're taking [on] a little bit of credit risk, so it seems to hold promise.
But as you mentioned, this is ... a niche category. It's a small category. Bank loan funds have the potential to be a small market. So if there are massive flows into this category, you could see dislocation with price and fair value. So I'd be cautious about going into these funds just because you think it's necessarily going to be safe in this environment. I would look first at the valuation, to see if you thought the category was attractive from a valuation standpoint as well.
Benz: I guess we also hope investors are mindful of the credit-quality risks in case things don't play out as maybe they're hoping it will.
Benz: We saw big losses in some of those funds in 2008.
I'd like to take a closer look, Mike, at the muni-bond area, especially in light of Detroit's bankruptcy filing. We saw outflows from the category, from that asset class, during the month of July.
Rawson: Flows to taxable bond were about neutral, but there were still really large outflows from municipal-bond funds. I think part of it is people moving away from interest-rate risk, but also the headlines of the Detroit bankruptcy filing are making investors a little bit nervous. Particularly there were a couple of funds that were focused just on the state of Michigan that had very large outflows, around 5% of their asset size, which is a large one-month outflow. So I think investors are skeptical, [and think] maybe the municipal-bond funds have a little bit more risk than they anticipated. And investors are really moving away from interest-rate risk there, because there is not as much credit risk in municipal bonds as there is just traditional interest-rate risk, because municipal bonds are generally pretty safe.
I think what you have there is primarily people moving away from interest-rate risk, but also some element of the headlines of the Detroit bankruptcy filing making people feel a little bit skeptical of the category. But I think that's a little bit of a knee-jerk reaction. I wouldn't rush out and sell my municipal-bond funds just because Detroit filed for bankruptcy, because that's something that's been known about in the market for some time.
Benz: I would think so.
Let's segue, Mike. I think we could talk a lot about fixed-income--that's been where a lot of the action has been. But let's talk about equity fund flows. You noted that investors continue to gravitate toward value styles and generally are shunning growth in this environment.
Rawson: For the most part, yes. Equity flows were pretty strong last month. Over the last several months, we've really seen equity flows pick up. It's a reversal of what we had in 2012. Investors are becoming more comfortable with equities.
We've had an economy that is slowly improving, not as volatile maybe as it had been in the recent past. I think people are feeling more comfortable with equities. They are still tilting toward the value side, and I think it's the attractiveness of the dividend payout that you see in some dividend strategies and some value funds. There may be some misplaced fixed-income investors moving into equities, saying I still want the safety of a dividend, or the a perceived safety of a dividend. So the value style seems to be attracting more flows.
But I think the good news is that flows into equities in general are more positive; it's a little bit more balanced flows from what we saw last year, where [money] was just going into fixed income.
Benz: I guess anytime you see this, though, after we've had such strong equity returns, and valuations certainly aren't what they once were, you do wonder, are investors doing a little bit of rearview mirror driving and maybe just performance-chasing?
Rawson: Absolutely. The time for performance-chasing would have been last year when equity markets were a little bit more attractive. Now our price to fair value from our equity analysts puts the S&P 500 at a fair valuation. So it's not as attractive as it was a year ago, certainly.
Benz: Let's take a look at the fund family view. You touched on PIMCO briefly. I'd like to look at Vanguard, because they had a rare month of outflows during June. You noted that they're back in the black for July.
Rawson: It's interesting. Vanguard typically has had very strong inflows, and …because they are so established in the retirement space, they have a lot of consistent inflows. But … in June they had outflows; last month, in July, they came back to inflows, but under the surface, it was still outflows from their fixed-income [funds].
Now, most of Vanguard's fixed income, as we were talking about, is passive, core bond type of portfolios and type of funds, and those were the bond funds that investors were tending to sell. Investors were moving into the higher-risk categories, and Vanguard doesn't have maybe as much to offer there. So they were selling out of Vanguard funds, but Vanguard had pretty good inflows into their equity products, so overall Vanguard had inflows last month.
Benz: JPMorgan is another firm that has been very aggressive in terms of asset gathering. Where have the big inflows come in the JPMorgan lineup?
Rawson: JPMorgan has had very strong flows to their equity products, particularly their large-cap growth equity funds, which is a bit surprising, because we just mentioned that the value style seems to be more attractive because of the dividend. So large-cap growth has done very well for JPMorgan. JPMorgan has really been able to increase their market share in terms of the total assets that they manage over the past year.
Benz: Mike, thank you so much for being here. It's always fun to explore this intersection between investor behavior and where they're adding their dollars.
Rawson: Thank you, Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.