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By Christine Benz and Kevin McDevitt, CFA | 09-13-2012 03:00 PM

Fed Action Keeping Bond Funds Popular

The Federal Reserve's bond purchases are contributing to greater inflows into fixed-income funds, while demand for stock funds is near multiyear lows.

Christine Benz: Hi, I'm Christine Benz for Morningstar. Since late 2008, assets in bond funds have jumped up by nearly $1 trillion and there is no end in sight. Joining me to discuss the latest trends in mutual fund inflows and outflows is Kevin McDevitt. He is a senior analyst with Morningstar. Kevin, thank you so much for being here.

Kevin McDevitt: Thanks for having me, Christine.

Benz: Kevin, this trend toward investors buying bond funds continues unabated. The Federal Reserve has kept rates down at zero, so what are investors responding to because the yields certainly aren't there for bonds?

McDevitt: As we've talked about for a while now, just you've had this long migration out of money market funds into taxable-bond funds for the most part, although municipal bonds to some extent, too, which we can talk about. But it seems to be this bifurcation in terms of where investors are going. It seems like about half the flows roughly tend to go more in the core areas of taxable bonds, the taxable-bond categories like intermediate-term and short-term. But then--and especially of late--you've seen a kind of resurgence of demand for more credit-oriented categories, things like high-yield bonds, emerging-markets bonds, multisector bond funds, and even bank-loan funds, which had been popular you may recall last year. They kind of declined in their popularity, but now the demand seems to be increasing again for bank-loan funds. As you alluded to at the beginning, I think a lot of this goes back to what's happening with the Fed, what's happening with central banks. The Fed of course announcing Sept. 13, they are going to continue with Operation Twist. They will continue to buy bonds as part of that program. So, in essence it's going to continue to facilitate greater flows into bond funds. It's hard to see what would really change this demand picture unless there is something like an unexpected spike in inflation or an unexpected spike in rates.

Benz: So, you are saying that even though yields on bonds aren't all that great, especially in high-quality land, they are better than the zero what that most investors are earning on their cash right now.

McDevitt: Yes, absolutely. I think that goes back to, it seems like investors are looking for one of two things. I think if you're more inclined to go for like a short- or intermediate-term bond fund, it's perhaps a bit more about capital preservation. You want it to do a bit better than you would do in a money market fund versus if an investor who is going more into the credit-oriented categories; it's more about yield-seeking in those cases. So again, you're seeing strong demand on both sides. I imagine perhaps there are different groups of investors for those types of funds.

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