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By Christine Benz and Michael Rawson, CFA | 10-14-2013 12:00 PM

Investors Continue to Take on Credit Risk

September and third-quarter asset-flows data show that investors remain cautious of interest-rate risk and a fully valued stock market, and instead prefer nontraditional bonds and foreign equities.

Christine Benz: Hi. I'm Christine Benz for Morningstar.com. Investors appear to be taking a cautious tack in the month of October based on recent fund flows. Joining me to discuss them 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, you said that fund flows during the month of September were pretty tepid overall in terms of flows into equity funds as well as bond funds. Let's talk about what investors were buying and what they were not buying during the month.

Rawson: Yes, flows to U.S.-equity funds certainly were tepid; we saw weak flows there and outflows again from taxable-bond funds. We did see some strong flows to international-equity funds. That [category] was a bit stronger, and it's been strong year to date. Investors may be finding value in international markets, whereas they're not seeing as much value in the U.S., and still we have this continuation of outflows from fixed income. Of course, June was the big month there where we had massive outflows, record outflows from fixed income.

Benz: Poor performance was driving some of that, I'm sure.

Rawson: Sure. We had interest rates really spike starting in May and June, and interest rates really went up throughout the third quarter. Then they settled down a little bit when the Fed decided kind of a surprise move that they weren't going to begin tapering, but still we've had continued outflows from taxable-bond and municipal-bond funds.

Benz: I want to drill into some of these headlines a little bit more, but first, you noted in your recent report that during the month of September anyway that money market funds led the way in terms of new inflows. What do you think is motivating investors to be looking at cash right now?

Rawson: Money market funds, as you mentioned, had strong flows for the month and really for the quarter. In fact, for the quarter, they had about $90 billion inflows. That beat out the $11 billion inflows in mutual funds and the $53 billion inflows into exchange-traded funds. Of the three, mutual funds, ETFs, and money market funds, investors seem to prefer money market funds. I think there are two things driving that.

First of all, we've had outflows from fixed income. There are probably a lot of fixed-income investors who are saying, "I need to shorten my duration [a measure of interest-rate sensitivity], so I am going to sell my intermediate-term bond fund and move to a money market fund."

Then I think also you have maybe some just caution on the part of equity investors or just investors generally that they want to put money into savings and are not sure whether they want to go into the equity market at this point where valuations might be fully valued. There maybe is not as much return potential in equities. So, they're choosing to go with the money market funds and are being a little bit cautious here.

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