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Investors Still Beating a Path to Bonds

Jason Stipp
Michael Rawson, CFA

Jason Stipp: I'm Jason Stipp for Morningstar.

We crunched the numbers on October asset flows--that's where investors are putting and pulling their money--and surprise, surprise, investors still are interested in bonds.

Here with me to dig into the details is Mike Rawson, fund analyst with Morningstar.

Thanks for joining me, Mike.

Mike Rawson: Thanks Jason.

Stipp: So, October data showed a continuance of assets flowing into bond funds. This is something we've seen for a while. What were the numbers, and how did they compare to the trend that we have seen?

Rawson: So about $30 billion went into taxable bond funds last month, and that's the continuation of a trend we've seen all year, really for the last several years. About $220 billion year-to-date have gone into bond funds. And while we saw strong inflows into bond funds during the financial crisis, but what's happening recently is these inflows into bond funds have kind of reaccelerated. And it's a bit surprising, because the equity market volatility has kind of calmed down a bit, and up until recently valuations were relatively attractive in equities, but we still see investors continue to flow into bond funds.

Stipp: And we've seen, on the flipside, outflows from especially U.S. equity strategies. And interestingly, outflows on the mutual fund side and on the ETF side, which is maybe something that we haven't seen on the ETF side as much. Can you talk about the trends there?

Rawson: Generally, flows into U.S. equity ETFs have been positive, but over the past several months, U.S. equity ETF flows have been a little bit weaker than we normally have seen. I think it points to the fact that the market is starting to get pretty much fairly valued, or closer to fair valuation, so I think investors are little bit more risk averse in terms of putting new money, even into passive strategies.

Stipp: As part of your analysis, Mike, you also looked back longer-term at some of the trends of investors and their long-term assets between equity and fixed income, and the shifts that we've seen. They are pretty dramatic and eye-opening. What did you find there?

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Rawson: Absolutely. So, if we go back about 10 years ago, we find that the percentage of assets that were in long-term mutual funds and ETFs that were in equities was about 48%. Fast-forward to today, and that's dropped to about 37%. So, investors are taking money out of equities. In terms of bonds, the percentage of assets that were in bonds started out at about 13% 10 years ago--that is doubled to about 26%. So there has been this dramatic shift from equities into bonds.

I think part of the reason for that is just the increased risk aversion among investors. A lot of investors got burned in the financial crisis. They don't want to take the risk in equities.

Secondly, in terms of their money market funds, investors are finding they are not getting any return from money market funds, so they are shifting some of their allocation that would've gone into money market funds into taxable bond funds.

Now, some people suggest that part of the explanation could be a shift in demographics. Obviously, the population is aging, even though I don't think over a 10-year timeframe demographics can explain that dramatic of a shift away from equities and toward fixed income.

Stipp: So big, big shifts in investors' portfolios that we've seen over that time period.

An interesting note: When you dig under the surface a little bit and look at where in the fixed-income spectrum investors are putting their money, it's not entirely risk aversion, or so it would seem, because they're also putting money in some of the riskier areas of fixed income. What are you finding there?

Rawson: Absolutely. It's bit of a paradox. So while investors are avoiding equity risk, they're kind of seeking out the higher-risk segments of the bond universe. So, emerging-markets bond, high-yield bond, multisector bond, or nontraditional bond--actually all of these are kind of non-traditional bond categories--those have all seen strong inflows. In fact, last month, each of those categories I mentioned saw more than a $1 billion in inflows.

While traditionally, these segments of the bond market would be seen as riskier, I think nowadays a lot of people are suggesting that maybe Treasury bonds are where the real risk is. Obviously, you've got real interest rates in Treasury bonds negative. You've got the economies of some of these emerging markets being very strong; they don't have as much debt as the U.S. does. And you're gaining a little bit of a higher yield in these other areas. So I think people are starting to perceive those other areas of the bond market as being less risky.

Stipp: If the fundamentals may point to some strength for some of those areas, what about the volatility? Do you think investors are prepared for the volatility they may see, for example, in emerging-markets bonds if they hit a rough patch? Are they mentally prepared for that in [these] riskier slices of the bond market?

Rawson: I don't think they are. You traditionally think of your bond allocation as being the safe and core part of your nest egg, the part of your portfolio that's going to hold up well during crisis. And Treasury bonds have played that role traditionally. I don't think emerging-markets or high-yield bonds are going to hold up that way. In fact, for high-yield bonds, high yields typically have been more highly correlated to equities than they have to fixed-income Treasury bonds.

Stipp: Digging under the surface a little bit on individual funds and fund firms: Who were some of the big gainers in the October data? Who got the most assets?

Rawson: PIMCO again was the leader in terms of asset gatherings last month, led by their PIMCO Total Return Fund, which gathered in $2.4 billion. So that continues to be a popular fund among investors.

I think somewhat surprising is the DoubleLine Total Return Fund--that fund year-to-date has gathered about $18 billion. It's the most popular fund year-to-date. And that's really surprising because that fund didn't exist three years ago. Obviously, Jeffrey Gundlach has been around for long time, but this is a new fund, and it's been quite successful, quite popular among investors.

Another fund firm that did really well last month is iShares. iShares, an ETF provider, gathered in about $7 billion in flows, despite the fact that ETFs overall only took in $2 billion. So, iShares pulled more than its weight, and I think that had part to do with a new strategy where they launched a core series of ETFs with really low pricing, targeted to buy-and-hold investors. So, they launched this series of ETFs, which I think are going to be really popular among investors, and they also launched out an aggressive marketing campaign. They had full-page advertisements in The Wall Street Journal, television commercials, even during the presidential debates, they had a television commercial. So I think they came out with a pretty aggressive marketing push, and I think that helped them gather assets.

Stipp: Another asset-gathering part of the investment universe is alternatives. This encompasses a wide array of strategies. When you look at the alternatives space and where the assets have gone, what are investors preferring among those funds?

Rawson: Well at last month, it was really long-short and bear market funds, which I think indicates, again, investors trying to hedge their downside risk. Those two Morningstar categories within alternatives gathered the most assets last month, and alternatives overall have been the fastest growing. They grew at about a 16% organic growth rates. So again, I think that's a sign that investors think that the equity markets may be fully valued and are trying to hedge their risk somewhat.

Stipp: So in some ways the story in October is a little bit the same of what we've seen before, but definitely some interesting details when you dig beneath the surface. Thanks for joining me, Mike.

Rawson: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.