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By Christine Benz | 01-18-2011 02:57 PM

Where Bond Investors Pulled and Placed Their Bets

Morningstar's Kevin McDevitt on the inflow and outflow trends in fixed-income funds as 2010 drew to a close.

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

After favoring bonds for the better part of two years, investors retreated from the asset class in 2010's waning days.

Here to add some color on what we're seeing in terms of mutual funds' inflows and outflows is Kevin McDevitt. He is editorial director for Morningstar.

Kevin, thanks so much for being here.

Kevin McDevitt: Thanks for having me.

Benz: So, Kevin, it was a really strange close to the year in that we saw dramatic outflows from bond funds. Can you talk about where investors seem to be subtracting the most money, and what they were responding to?

McDevitt: Sure. The most dramatic outflows were in municipal bond funds. We saw outflows of nearly $14 billion last month alone, and that's on top of about $7 billion the previous month. So, that's $20 billion in two months, and that's about 4.5% of overall assets. So, that's a huge reversal from the previous year.

Benz: So, investors might have been looking at a couple of things. I think the initial headline was, "Oh, they are worried about what's going on at state and local municipalities." But, it seems like maybe there were some other things in the mix as well.

McDevitt: Sure. I think, right, there was a lot of headline risk you had. You had the 60 Minutes piece with Meredith Whitney. And you also had just general headline risk with what's happening with municipalities, as you said.

You also had some other factors, too; you had the extension of the tax cuts, which I think perhaps you had investors buying these funds thinking they want to have some income protection, but that ended up not being really a good basis anymore.

Benz: So, if people thought tax rates were going to go up, munis would be a good place to be, but then there was a sell-off when it didn't appear that taxes were going up?

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