Investor Cash Flows Back to Bond Funds

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. There were strong flows into funds throughout the first quarter, including the last month of March. I'm here with Mike Rawson, a fund analyst here at Morningstar, to see what's behind these numbers.

Mike, thanks for joining me today.

Mike Rawson: Thanks for having me, Jeremy.

Glaser: Let's start by looking at intermediate-term bond. This is a category that has been really beaten up throughout last year and had a negative return. Investors really kind of ditched it as they were worried about rising rates. We saw inflows in to this category first time in 11 months. What's behind this? Why are investors putting money to work in bonds again?

Rawson: That's a good question, Jeremy. There were really massive outflows from intermediate core bond funds last year, and there's been this sort of shift where investors have certainly tiptoed back into bond funds. Last month particularly we saw that. And I can only speculate that it is most likely that we are seeing that interest rates have already ticked up quite a bit, at around 2.7%; that the yield has started to look more attractive.

Additionally investors may be thinking the stock market is fully valued. The stock market is starting to look a little bit more volatile here these past few days, so investors might be thinking they still want that bond part of their portfolios for safety. So you mentioned the strength in the bond flows, I think they would have even looked even stronger if it hadn't been for PIMCO Total Return, which still had outflows last month.

Glaser: Let's take a closer look at that. Obviously, PIMCO has been in the news a lot lately due to some manager changes, particularly the high-profile departure of Mohamed El-Erian. Did you see an impact in PIMCO's flows?

Rawson: I think that's the only conclusion we could make. Last year PIMCO had very strong outflows. That was to be expected because PIMCO is mostly well-regarded as a fixed-income shop. So they had strong outflows from their fixed-income funds just because people were selling fixed income in general.

But last quarter other firms have started to have inflows in their fixed-income funds. PIMCO still had outflows in a lot of categories, which other firms are seeing inflows. So in fact, in terms of the top 10 asset managers, PIMCO is really the only firm to have outflows from their funds.

<TRANSCRIPT>

Glaser: Is this monolithic or is it just really Total Return, while maybe some of their other funds are still doing a bit better in terms of flows?

Rawson: Some of their funds are doing better. PIMCO Income is one fund that is doing better. But then there are some funds where I think there is some uncertainty there about the management, and there have been outflows and maybe some uncertainty about performance, as well. PIMCO Unconstrained is a good example. PIMCO Unconstrained is in this nontraditional bond category, a category that has been very popular because it's being pitched to investors as a category which should do well if interest rates rise. Well that sounds great.

The only problem is these funds are relatively untested, and like the name implies, they are nontraditional. So this fund had maybe weaker-than-expected performance and a manager change. Bill Gross actually stepped up to take over that fund, and it's continued to have outflows, whereas some of the other funds in the category are having inflows.

Glaser: Outside of those fixed-income funds, PIMCO of course also offers some funds of funds or some allocation funds. Are there any interesting things happening with those right now?

Rawson: PIMCO has these two popular funds of funds. These are asset-allocation funds, which invest in individual PIMCO funds. One is called PIMCO All Asset. The other one is called PIMCO All Asset All Authority. These funds are subadvised by Research Affiliates, which is the firm that Robert Arnott is associated with. These funds were very popular a couple of years ago. They have started to see some outflows.

One interesting thing that we observed last month is that there appeared to be a switch from these two international fundamentally run funds into two international low-volatility funds. So the interesting thing is that we only see the holdings of PIMCO All Asset All authority on a quarterly basis. But we could see the assets monthly. So you start to get a little bit of a peek at what the portfolio manager is doing with these funds.

And the shift from fundamentally oriented funds in international markets to these low-volatility funds sort of suggests that maybe the portfolio manager is expecting lower returns. Low-volatility funds are kind of expected to do better when the market underperforms. They are not going to go up as much when the market rallies, but when the market sells off, a low-volatility fund should be less volatile.

We are not certain that this transaction took place, but we do see the flows. We saw massive outflows from these fundamental funds and massive inflows from corresponding low-volatility funds. So it just appears as if those are shifts that the Research Affiliates team is making.

Glaser: It sounds like Arnott and his team might think that there could be a sell-off. But looking at global valuations, looking at how much stocks have run up, are investors kind of taking money off that equity table, maybe putting it elsewhere, or is there still money flowing in into equity funds?

Rawson: That's a great question, Jeremy, because equity market valuations, at least if you look at our Morningstar equity Analyst Reports, the equity market appears to be somewhat fairly valued. The market has run up so much, you might expect to see a lot of outflows from equities, and that's not what we are seeing. Equity markets, particularly the U.S., have maintained inflows.

International developed markets have actually had very strong inflows. People are going into Europe. And even emerging markets, which had been in outflows, are starting to see some inflows back into emerging markets, particularly on the ETF side.

Glaser: Mike, I appreciate your analysis of the flows today.

Rawson: Thanks, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser.