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Investors Flip Flop on Bond Funds

With the Fed signaling a slowdown in rate increases, bond investors have decided it's safe to go back into the water.

Note: This is an excerpt from the Morningstar Direct U.S. Asset Flows Commentary for February 2019. The full report can be downloaded here.

Long-term flows in February 2019 were a strong $53.5 billion, their best month since January 2018. Money market funds took in a robust $41.3 billion. For the first two months of 2019, long-term flows were $92.7 billion, marking a strong start to 2019. Trailing-12-month inflows were $117.4 billion, just $24.7 billion more.

However, demand was largely limited to taxable-bond and municipal-bond funds, which brought in $37.3 billion and $11.2 billion, respectively. It was the latter's greatest haul since September 2009. With the Fed signaling a slowdown in rate increases, bond investors have decided it's safe to go back into the water. That renewed confidence showed in February's most popular taxable-bond categories, intermediate-term bond and high-yield bond, which collected $15.5 billion and $5.6 billion, respectively. Multisector bond fund PIMCO Income's (PIMIX) flows reflected this trend. It took in the most money of any actively managed fund in February with $3.2 billion, which followed $2.0 billion in January inflows.

This stands in stark contrast to the fear that gripped bond investors in late 2018. These two categories were mauled by outflows in the fourth quarter as the Fed raised rates and hadn't yet signaled a willingness to stop. Intermediate-term bond funds lost $31.3 billion to outflows and high-yield bond funds lost $19.8 billion during the quarter. Instead, investors fled to the safety of high-quality, short duration funds during 2018's fourth quarter. Ultrashort bond funds were the greatest beneficiary as they took in $33.8 billion during the quarter.

But with the Fed held at bay for now, investors have lost interest in short-term bond funds. So far in 2019, ultrashort bond funds have collected just $3.8 billion, with short-term bond and short-government funds contributing about $5.0 billion combined. Indeed, some of February's most heavily redeemed funds were short-term funds.

Meanwhile, municipal-bond funds can just about call it a year with $18.7 billion collected so far in 2019, which is just $2.0 billion shy of the trailing-12-month total. Muni-bond funds are off to such a strong start in 2019 because they were generally cheap compared with Treasury bonds entering the year.

In contrast to bond funds, U.S. equity funds collected just $3.2 billion in February and international equity funds just under $1.0 billion. Passive U.S. equity funds took in nearly $13.1 billion, while active U.S. equity funds lost $9.9 billion to outflows. Passive U.S. equity funds increased their market share to 48.8%; in terms of total assets, they now trail active U.S. equity funds by just $200 billion. However, they probably won't erase that gap entirely until late in the year.

Other key takeaways from this month’s fund flows report include:

  • Core strategies continue to do well. The two best Morningstar Categories were the aforementioned intermediate-term bond and large blend ($9.2 billion).
  • Active funds had a decent month with $11.4 billion in inflows. This was just the group's fifth month with more than $10 billion of inflows during the past three years. Passive funds collected $42.2 billion.

  • Even though its funds aren't always the cheapest, Vanguard dominated overall inflows with $20.5 billion, followed by Fidelity's $9.5 billion. Vanguard’s overall market share is now 25%.

Kevin McDevitt does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.