American Springs a Leak as Investors Pour Money into Bond Funds

The third quarter proved to be a big comeback month for inflows into U.S. open-end mutual funds. During the three-month period, investors contributed $144.7 billion to funds, taking the year-to-date total to $273.2 billion. Meanwhile, $188.2 billion exited U.S. money market funds.

Bond funds continued to capture the vast majority of the inflows in the third quarter. Meanwhile, flows into equity funds have been tepid in spite of the broad stock market recovery. Although the S&P 500 has gained more than 19% so far this year, investors have placed only a net $3.8 billion back into U.S. stock funds.

After the market's nose dive last year, many have sought safety in lower-volatility investments like bond funds. However, investors may be in for a shock when rates eventually rise, and they definitely shouldn't get used to the double-digit returns that many core bond funds have notched so far in 2009. We're not forecasting an imminent rate hike; however, when rates do eventually move, the most likely direction will be up and that will put pressure on bond prices and fixed-income fund returns.

Estimated Net Flows ($Mil)

 
American Funds Spring a Leak
The outflows for U.S. stock funds in September can largely be attributed to American Funds. Among the least popular U.S. equity funds in September were  American Funds Washington Mutual (AWSHX),  American Funds Growth Fund of America (AGTHX), and  American Funds Investment Company of America (AIVSX), which saw outflows of $620 million, $334 million, and $417 million, respectively.

In total, investors pulled $1.8 billion out of American Funds in September, continuing a trend that has plagued the firm all year. For the year to date through September, the firm has registered outflows of $19.3 billion, while the other major firms had inflows.

Like most other firms, American Funds' bond offerings have experienced strong inflows. So far this year, its fixed income offerings have taken in $9.2 billion. But that hasn't been enough to offset the flood of dollars exiting the firm's equity and balanced fund offerings.

American Funds' business mix has worked against it this year. Its key rivals, Vanguard and Fidelity, have a more diversified menu of funds, while American Funds' mutual fund lineup is significantly skewed toward equities. Just over 11% of the firm's mutual fund assets are in bond funds (both taxable and municipal). Meanwhile, equity funds make up around two thirds of the firm's mutual fund assets, with the remaining going to balanced funds.

Granted, with $880 billion in total mutual fund assets, American remains the second-largest U.S. fund firm. But its market share has definitely been under pressure in 2009.

Vanguard Tightens Its Grip on Number One
Meanwhile, Vanguard has solidified its place atop the U.S. fund charts. The firm came through 2008 in better shape than its competitors, and it has continued to gather assets in 2009.

That said,  Vanguard 500 (VFINX) was the least popular U.S. fund in September, with outflows of $631 million. However, this may not be a story of investors abandoning S&P 500 indexing. More than $445 million of those outflows were attributable to the Signal share class , which requires a minimum investment of $1 million. Meanwhile,  Vanguard Institutional Index (VINIX), which also tracks the S&P 500, saw inflows of $497 million. So it's certainly possible that an institutional shareholder was swapping out its Vanguard 500 Signal shares for the cheaper Vanguard Institutional Index.

As you might expect, flows into Vanguard this year have been heavily skewed toward bond funds. In fact, only two of the firm's 10 most popular funds in 2009 are equity funds-- Vanguard Total Stock Market Index (VTSMX) and Vanguard Institutional Index.

In total, investors poured $27.4 billion into Vanguard funds during the third quarter and $74.2 billion so far this year. The pace of the inflows prompted Vanguard to post a warning on its Web site, cautioning investors against "using short-term performance figures--however attractive--to guide [their] investment decisions." The firm singled out four funds in particular-- Vanguard Capital Value  (inflows of $239 million through September),  Vanguard Emerging Markets Stock Index (VEIEX) (inflows of $1.4 billion),  Vanguard Precious Metals and Mining (VGPMX) (inflows of $481 million), and  Vanguard High-Yield Corporate (VWEHX) (inflows of $1.7 billion). Vanguard has a long record of staving off hot money into its funds, not only through warnings like these but by raising investment minimums and occasionally closing funds.

Sure enough, only a few days after posting the warning on its Web site, Vanguard announced that it was closing Vanguard Capital Value to new investors in what the firm called a "cooling off period" intended to protect existing shareholders from transaction costs incurred when short-term performance-chasers move in and out of a fund.

Granted, the vast majority of new inflows this year have gone into staid bond funds, but that's masked performance-chasing that's been going on just under the surface. As evidence, the two most popular equity categories this year are diversified emerging markets and natural resources, which have experienced strong inflows of $12.7 billion and $9.3 billion, respectively.

PIMCO Won't Turn Off the Spigot
Given its track record, we weren't surprised to see Vanguard close a fund to keep hot money out. However, the same can't be said for the hottest fund on the market,  PIMCO Total Return (PTTRX). Bill Gross, the fund's manager, recently said that he doesn't plan to close the fund as long as it's beating the market and the competition.

Vast sums have been flowing into PIMCO Total Return all year, and September was no exception. It was once again the most popular fund this month with $5.3 billion in inflows. So far this year, the fund has taken in an amazing $36.3 billion, and it now stands at $185.7 billion in total assets.

Although the growth of Total Return has been astounding, it's not the only fund in PIMCO's lineup that has taken in scads of cash.  PIMCO Commodity Real Return (PCRIX) has gathered $5.1 billion so far this year, and  PIMCO Short-Term (PTSHX) has had inflows of $4.7 billion. PIMCO Investment Grade Corporate (PIGIX) and  PIMCO Low Duration (PTLDX) have also been popular, with each taking in around $3.3 billion.

Other Fund Company Highlights
JP Morgan had a strong third quarter. The firm saw $8.2 billion in inflows for the quarter and has pulled in $16.8 billion for the year to date.  JPMorgan Core Bond (PGBOX) has been the firm's big winner this year, with $4.7 billion in inflows. That fund is managed by a veteran team that has witnessed all sorts of market conditions. That experience paid off in 2008, when the fund weathered the extreme conditions much better than most competing funds, and that's earned it new fans this year even though the fund has underperformed so far in 2009.

A fund run by another experienced manager has also helped lift BlackRock's results.  BlackRock Global Allocation (MALOX) has taken in $4.1 billion through September, helping push the firm's total year-to-date inflows to $6.6 billion. Dennis Stattman, who has run the fund since its 1989 inception, grew cautious about corporate debt and the financials sector at just the right time, and the fund held up much better than the competition in 2008 as a result.

Another veteran manager, and early contender for Morningstar's Fixed-Income Manager of the Year, Jeffrey Gundlach, has also seen noteworthy inflows into his fund,  TCW Total Return Bond (TGLMX). That fund, which has experienced $6.7 billion in inflows so far this year, is the 800-pound gorilla in TCW's lineup. At $10.0 billion in total assets, it accounts for the bulk of the firm's $13 billion in mutual fund assets.