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By Christine Benz and Eric Jacobson | 04-03-2013 12:00 PM

Bond-Fund Investors Walking Gingerly

First-quarter flows into many bond-fund categories were tepid compared with their equity counterparts, with improving economic conditions creating a Treasury sell-off.

Christine Benz: Hi. I'm Christine Benz for Morningstar.com. Stock funds posted very strong gains in the first quarter of 2013, but bond funds didn't fare as well. Joining me to provide a recap of the first quarter for bond funds in 2013 is Eric Jacobson. He is a senior fund analyst with Morningstar. Eric, thank you so much for being here.

Eric Jacobson: Sure. Glad to help, Christine.

Benz: Eric, when we look across the numbers for the first quarter, what we see is that bond funds didn't generate terrific returns in absolute terms, but some of the categories that did post relatively better numbers were some of the riskier categories. Let's talk about the types of funds that led the way in the first quarter.

Jacobson: Sure. Well, it's lot of the same story that we've talked about before in terms of what we've probably described as risk-on. The strongest categories during the first quarter were high-yield bond, the bank loan, and multisector bond, which has typically quite a bit of high yield and bank loan credit in it.

Benz: Is the thesis that investors are thinking, if the economy is improving, that in turn will help companies be able to pay their debts, companies with perhaps low credit ratings? What's going on there?

Jacobson: Yeah, to add a subjective look at it, I think some of that is justification for allowing people to feel comfortable with continuing to buy these credit-sensitive sectors that are getting richer and richer. As the yields go down and it generally becomes harder to think about, "Well, how am I going to get more return out of this," it's easy to take a look at the economic data and say, "well, things are going well, the default risk is relatively clean at this point, and so we can justify buying things at these lower yields."

Benz: So it sounds like you are concerned that there is kind of some yield-chasing going on, that's why investors seem to be buying some of these higher-income-producing categories?

Jacobson: Well, everybody is trying to find an alternative to Treasuries right now, and even mortgages don't have as much fire in them as they once did, and I'm speaking specifically about agency mortgages. So there is this just massive search on for anything that doesn't look as tight and risky as Treasuries. So, again, it comes back to, whether or not you want to call it yield chasing or not, that's pretty much I think what's going on. It’s just that it's even broader and inclusive of probably more investors than usual.

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