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Investors Continue Their Quest for Yield

Christine Benz
Michael Rawson, CFA

Christine Benz: Hi, I'm Christine Benz for Morningstar.

Investors continued their quest for yield in the first quarter, according to Morningstar's latest fund flow data. Joining me to provide some color on the latest data is Michael Rawson; he's a fund analyst with Morningstar.

Mike, thank you so much for being here. 

Michael Rawson: Thanks for having me, Christine.

Benz: When you look across the first-quarter data, Mike, you noted in a recent commentary that investors seem to have this appetite for yield and that's where they are putting their dollars. Let's talk about some of those categories that have been the beneficiary of that appetite for yield. 

Rawson: Certainly. Just to start off, the first quarter was a very strong quarter for fund flows, particularly if you go back to January, people were talking about maybe the great rotation. A lot of money came into the market and was going in all places, whether it be fixed income, even into equities, money was just flowing all over the place.

Benz: Coming out of money market mutual funds. 

Rawson: Coming out of money market mutual funds and into the long-term mutual funds, which was a good sign for investors' risk appetite overall. But certainly last month, we saw the flows into equity funds kind of moderate, flows into fixed income stayed strong. And within fixed income, investors were definitely willing to take on a little bit more credit risk than we have traditionally seen in the past.

Benz: So let's talk about some of those categories that exemplify the trend. Not necessarily government bonds, but the more credit-rich categories. 

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Rawson: Yes, leading the list was bank loan, which of course is a category where you're taking on a lot of credit risk there, not as much interest rate risk, but a certainly lot of credit risk.

And we've seen strong flows into also shorter-term bond funds, not government bond funds, just general bond funds. So people are maybe somewhat concerned about duration and maybe interest rate risk. They want to focus little bit more on credit risk; they see maybe a potential, even though yields are really low, maybe those spreads could go a little bit lower. So, they're willing to accept some credit risk as they've seen economy improve. They've figured maybe yields could come down even a little bit more, but still shying away from interest rate risk. 

Benz: Another, relatively new category for us is this nontraditional bond category; we're also seeing some good flows there. What's going on?

Rawson: Well, again, I think people are hearing a lot of bond market pundits talking about the risk of interest rate being so low that you're not going to get a further decline in Treasury rates certainly, and if anything, Treasury rates are more likely to go up than down. So if you're going to put money into bonds, you maybe want to diversify away from your traditional bond fund, certainly government fund, and either take more credit risk, or maybe some currency risk thorough emerging markets. So certainly these nontraditional bond funds are taking on more strategies that wouldn't be prevalent in a traditional bond fund. 

Benz: OK. But we did see strong flows into some of the core type products as well. Let's talk about the biggest asset gatherers. There will be some familiar names for people who have been watching us talk about fund flows recently. PIMCO as well as DoubleLine…

Rawson: Well, actually, what's interesting is that PIMCO and DoubleLine really dominated flows in the fixed-income area last year. In the first quarter of this year, their two main funds who have kind of lost favor, so they haven't been as popular in terms of inflow. PIMCO Total Return Fund actually hasn't been the leading fund this year. It's been PIMCO Income and PIMCO Unconstrained Bond, two different bond funds have actually led for PIMCO, and DoubleLine's Total Return Bond Fund actually hasn't had very strong flows. So what was popular last year is not as popular this year. I think investors, again, are seeking out more niche areas of the bond market, and being a little bit more tactical with their bond investments. So again, it's that nontraditional bond or bank loan categories are gaining more assets rather than these broad general bond funds. 

Benz: Let's shift gears and talk about equity fund flows. You noted that they were actually pretty impressive in the first quarter, but maybe not that great rotation into equities that a lot of people have been waiting for.

Rawson: Yes. So January, of course, was a very strong month for equity flows. It was a real shift from what we've seen in 2012. People thought it was a start-up of something new. Well, March flows moderated quite a bit, so maybe you have to back away from that story. Flows were still positive, which is a good sign, but they weren't very strong. In fact, it was more of the same, where flows are going to passive products, and equity investors are really pulling money out of actively managed funds. So, it was a little bit disappointing from that regard. ETFs of course were very strong--and most of the ETFs being passively managed--they continue to gain favor with investors. 

Benz: I want to back up and talk about passive versus active in a second, but first I just wanted to touch on something that jumped out at me, which is these very strong flows into international funds even through performance has in many cases lagged that of U.S. focused funds.

Rawson: Yes, I think investors are continuing to get more comfortable with the fact that the world is a global place, and your investments need to be global as well. So we've heard about this concept of home bias where people have more of their assets invested in their home country, just because they are more familiar, they are more comfortable, maybe they know more asset managers, they're familiar with the names of the banks and the people that are running their money, so they feel more comfortable with that. 

Well, they've started consistently, really over the last 10 years, putting more and more of their money internationally. The international economies make up a bigger part of the global economy, so I think it's important that you have some of your assets invested globally. In particular, they are putting a lot of money into emerging markets--they remain popular--and when they go that route, they are often picking a passive fund, maybe just because they don't really have an active manager in mind, so they just go the passive route. So several emerging-market passively run funds have gain a lot of assets.

Benz: Now, I would like to talk about this passive versus active divide. Is that something you see when you look at where the fixed-income flows are going? You noted that internationally as well as in U.S. stock funds, we're seeing strong flows there, how about in bonds? 

Rawson: Well, of course, Vanguard Total Bond Market Fund--and Vanguard's bond funds in general--are really strong, just like Vanguard's equity index products. So it appears that indexing is still popular on the bond side, but really I think on the bond side it's not as much of a story of active versus passive, it's more of a story of people just taking on more risk. So I think whereas in equities, it's pretty clear that there's a preference for passive, I don't think in fixed income it's as cut and dry. I think with fixed income people are looking to diversify their bond portfolios and go into those higher-risk segments.

But of course, the data is somewhat skewed by Vanguard. Vanguard is just a 900-pound gorilla, and whatever happens to Vanguard, it looks like it's happening to the whole fund universe overall. Vanguard consistently every month, month in and month out, has strong flows to all their passive products. So it looks like maybe investors are putting a lot of money passively into fixed income, but really I think that's more of a Vanguard story than it is about investor preference for fixed income or passive. 

Benz: We've talked about Vanguard, we've talked about PIMCO being some of the biggest beneficiaries of new investor flows. Any other firms jump out at you, either in terms of asset gathering prowess or those that have been losing assets?

Rawson: Well, last month both the JPMorgan and DFA--Dimensional Fund Advisors--gained more assets this month and last quarter than you would expect from their market share. DFA is an interesting case. They have had good performance, and they have a really long-term track record, and it's a fund company that we like. However, over the past several years, they've had outflows, which is kind of unique for them, because they work very hard to attract financial advisors that are going to stick with them for the long term. So they kind of reversed that trend last quarter; they had strong inflows. 

Benz: Well, Mike, it's always great to talk about investor behavior and talk about how investors are allocating their assets. Thank you so much for being here to provide this commentary today.

Rawson: Thanks, Christine. 

Benz: Thanks for watching. I'm Christine Benz for