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By Christine Benz and Michael Rawson, CFA | 12-13-2012 01:00 PM

Fear Still Driving Investors to Bonds

Inflows to fixed-income products continued in November on account of market-volatility worries, while equity outflows this year could surpass 2008 levels.

Christine Benz: Hi, I'm Christine Benz for Despite a very strong equity market for the year to date in 2012, investors continue to shovel money into bond funds. Joining me to discuss the latest trends in fund flows is Michael Rawson. He is a fund analyst with Morningstar.

Mike, thank you so much for being here.

Michael Rawson: Christine, thanks for having me.

Benz: The headline here when we look at fund flows, it's a familiar one for the month of November. Outflows from stock funds, big inflows into bond funds. Let's start with the winners. What categories within the bond-fund universe are investors buying?

Rawson: Sure. So, as you mentioned, we've seen this consistent selling out of equity funds and consistent inflows into bond funds. Investors are looking toward intermediate-term bond funds. They are also looking to take a little bit more risk in their bond-fund categories, going into emerging-markets bond-fund categories. The bank-loan [fund category] has also been a winner. High yield has been very successful year to date, even though last month, we did see some profit taking from high yield, so they experienced about $3 billion worth of outflows last month. And it's not surprising because high yield has run up so strongly so far this year.

Benz: Yields are so low on so many of these products, especially sort of those core intermediate-term funds. What's your sense of what investors are thinking in terms of preferring bond funds and what has been a very good year for the equity markets?

Rawson: Well, I think it's that fear. Investors still have this fear of the volatility that's in the markets, and perhaps there is some fear of potential changes in the tax code. So, the stock market has been up, perhaps people are using this as an opportunity to sell stocks now ahead of potential changes in the tax code. And so we actually saw a pretty big flow into money market funds last month, about $73 billion, which was one of the largest flows into money markets for a single month for over a year.

Benz: Are you concerned about some of the flows we've seen into the higher-risk fixed-income categories that investors are maybe barreling in there in search of higher payouts than they can get on the high-quality bonds and bond funds but maybe they're not fully acknowledging the risks?

Rawson: That certainly is a risk that investors aren't fully aware of the role of bonds in their portfolios and how the different bond categories stack up in terms of risk return. We know government bonds traditionally have been the safe anchor portion of your portfolio; for emerging-markets bonds, bank loans, high-yield bonds, those categories tend to be a little bit more correlated to risk in the market. If we were to see a massive sell-off in stocks, those bond categories probably wouldn't hold up as well, and so, investors' portfolios probably aren't going to be as safe as they would have been had they had been fully invested in government-type bonds.

Now, of course, there is the argument that government bonds are now riskier than they had been in the past. Certainly yields are very low, and there is a potential that yields could spike. Also, there is a potential that there could be inflation. So, people have changed their perception about bonds in general.

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