Sun, 18 May 2014
As rates have failed to rise as expected, investors have warmed back up to core bond funds, says Morningstar's Mike Rawson.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com.
Investors continue to buy stock funds, but the biggest surprise in the latest fund flow data was their embrace of bonds.
Joining me to discuss the latest fund flow numbers is Michael Rawson, a fund analyst with Morningstar.
Mike, thank you so much for being here.
Michael Rawson: Thanks for having me, Christine.
Benz: Let's start with the headline: Bond funds saw very good inflows in April. Why do you think investors are gravitating to bonds at this point?
Rawson: That's a good question. Interest rates rose quite a bit toward the end of last year in anticipation that the Fed's tapering would cause rates to rise, and I think that was a little bit of a knee-jerk reaction in anticipation that rates were going to automatically rise. When Janet Yellen assumed the role of chair of the Federal Reserve, she has made it clear that she is going to be somewhat dovish. She wants to make sure the economy is really improving before she actively raises rate.
So the rate rise that we had was more of an expectation, not an actual action on the part of the Fed. So we've had actually rates come down quite a bit, and investors have warmed to the idea that maybe I shouldn't be selling bonds at this time.
Benz: Bonds have rallied. They've had pretty good performance. Do you think there's some performance-chasing going on as well?
Rawson: There could be; there's always an element of that. It seems that flows and performance are sort of coincidental. We don't really know if one causes the other. But there's a reason why people hold bonds in a portfolio, and it's for diversification and for ballast, and I think investors need to remember that. It's not just for the current income that you're holding bonds.
Benz: When you look at the types of bond categories that have been seeing new flows, where do investors seem to be placing their bets?
Rawson: As you mentioned, the flows going back into bonds was a surprise, and particularly to the intermediate-term bond category, your core bond funds that you would use as the core part of your bond portfolio. Those funds had inflows, and that's a new thing. This is only the second month that they've had inflows in about a year, because there were such strong outflows last year.
But two other categories that have had inflows is non-traditional bond and multi-sector bond. Non-traditional bond has a lot of bond funds that are able to take long and short positions in terms of credit or maybe vary their duration. These are bond funds that are certainly more active, and so you need to do a little bit more due diligence before you pick a non-traditional bond fund.
Benz: One headline that surprised me was that bank-loan funds, which we've been watching because flows have been so robust, actually were among the biggest losers in the month of April. What's going on there?
Rawson: For several years, we've had strong flows into bank-loan funds on anticipation that, if the Fed raises rates, bank-loan funds should hold up better because they have a variable rate feature to them--the rate adjusts; it's a floating rate. Really, what you're getting with bank-loan funds is credit risk. And I think--I can only speculate--that what investors are seeing now at this point is that credit has improved so much, there's really not much further potential improvement that you can see in bank-loan funds. And interest rates really aren't as much of a concern, so maybe you have people saying, I don't really need these bank-loan funds at this time, and the credit can't really improve much more than it already has. So maybe it's not an ideal time to buy bank-loan funds.
Benz: Before we leave bond funds, I want to talk a little bit about PIMCO. We've been watching what's been going on at PIMCO. They had some personnel changes earlier this year, and we have seen redemptions in certain PIMCO funds, including the big Total Return Fund. What do you see when you look at the numbers from April in terms of what's been going on at PIMCO?
Rawson: Well, it's really shocking if you look at the magnitude of the number. It's just a huge number. And you have to remember, PIMCO is one of the largest fund providers out there. Over the course of the past year, it's been something around the order of $80 billion or so in fund outflows. In terms of their assets, their assets have gone from a peak of around $600 billion to about $500 billion. That's a tremendous drop. But you also have to remember that PIMCO's assets really exploded over the past couple of years, in 2009 to 2012, when there were these massive inflows into bond funds. So I feel bad that PIMCO is having a rough time, but you have to remember that their assets really are still up quite a bit. It's not as if they are really struggling.
The thing I would be concerned about for PIMCO is if they expanded hiring, if they hired a lot of staff, at this point they maybe can't afford to do the kind of hiring that they were doing on the margin before. Their bonuses probably aren't going to be as high as they were in 2012. But the firm overall is not hurting. I wouldn't say that they're somehow now in bad shape because their assets are down over the course of the past year, because their assets are still up over the course of the past several years. If you take a longer-term perspective, PIMCO is still in very good shape, and I'm sure that they're not worried about their assets or their profitability. In the long term, I think they're doing just fine.
Benz: Let's shift gears and talk about what's going on in the equity-fund universe. Within domestic equity, you noted in your recent report that we continue to see this strong preference for passively managed products. Do you see anything dislodging that trend, or do you think it's here to stay?
Rawson: There are two elements to the flows into passive. One is the dollar-cost averaging, the investor who saves a little bit every month in a 401(k) plan. A lot of that does flow into passive funds, particularly Vanguard, because Vanguard has a lot of target-date and target-retirement series that use passive investments, and Vanguard is one of the largest providers of 401(k) fund managers.
But there is also the element--you see this particularly on the ETF side--of people using ETFs to speculate or trade, gain access to a certain asset class over short periods of time. Those flows tend to be more volatile.
I don't think either trend is going away. You're going to have people continuing to save into their 401(k) or their IRA, and a lot of that money is going to go to passive funds, and it will be there every month. And then you also have a lot of financial advisors or individual investors who choose to speculate using ETFs or passive products, but using them actively, and that's a trend that's not going away, either. I think people are going to continue to use those products. So, we will see passive continue to become a bigger part of the market.
Benz: When you dial into specific equity-fund categories that have been seeing inflows, the value-leaning categories have been doing relatively better. Large-growth continues to be the big loser in terms of fund flows. It has seen redemptions for several months running.
Rawson: Yes, and part of that is American Funds Growth Fund of America, which has struggled not from a performance standpoint, but really from a fund-distribution standpoint. It's a fund that is heavily sold by advisors, maybe they are A Shares where the advisor will collect a load on that. We've seen the distribution side of the industry change over the last several years away from load-based products.
But there's more to it than just American Funds Growth Fund of America. I think investors are leaning toward value because they see a little bit of a higher dividend yield. So I think investors who otherwise would have gone into a bond fund for … income are saying, well, I'm going to go into stocks; I'm going to pick a large-value fund, which might have an attractive dividend yield. So I think the income-oriented funds are attracting flows into that large-value segment.
Benz: You alluded to the fact that Vanguard continues to be a big winner in terms of garnering new flows. PIMCO has been losing some assets, but you think still is a solidly profitable firm.
JPMorgan and DFA (Dimensional Fund Advisors) continue to be some of the bigger winners. But one name popped out at me in your recent report, and that was Putnam, which is actually seeing some pretty good flows into some of their funds. Let's talk about that story and which specific funds investors are buying at Putnam.
Rawson: You mentioned JPMorgan. JPMorgan is getting strong flows into several of their funds. DFA is again benefiting from that passive trend.
But Putnam is more of an active fund shop. And if you drill down and see what's driving their flows, it's really just two funds, Putnam Capital Spectrum and Putnam Equity Spectrum. Both of these funds are run by a gentlemen named David Glancy, who came from Fidelity. He previously had managed Fidelity's Leveraged Stock Fund, and so he has a lot of experience picking leveraged companies. These are mid-cap companies, potentially with a lot of risk, and that's a strategy that has done really well over the past several years.
In fact, he's coming up on his five-year mark since these funds were launched, and right now they have 5 stars because their performance has been so good. But another reason why they look good in their category is because they're sort of a different animal. They invest in both corporate bonds and stocks, and he's able to shift the allocation between stocks and bonds. He's made all the right calls, but he's also been in an environment where you've been compensated for taking on risk. So it remains to be seen if these funds will hold up well if we go through a down cycle. But as of now, that's what's driving these flows to Putnam; it's just these two funds.
Benz: Mike, thank you so much for being here. It's always great to hear your insights.
Rawson: Thank you, Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.