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Do Fund Flows Show a Bond Bubble?

Christine Benz
Kevin McDevitt, CFA

Christine Benz: Hi, I am Christine Benz for Morningstar. Ongoing flows into bond funds have sparked discussion over whether we are in the midst of a bond bubble. Joining me to discuss that question is Kevin McDevitt. He is editorial director with Morningstar. Kevin, thank you so much for joining me.

Kevin McDevitt: Thanks for having me, Christine.

Benz: Kevin, let's start with this question. You recently took a look at inflows into bond funds and you compared them with the last big market-centered bubble that we had back in the second half of the 1990s. Let's talk about what you found. How does the magnitude of fund flows compare with what we experienced back then?

McDevitt: The biggest surprise for me was that in absolute terms, what we're seeing in terms of flows into bond funds today versus those that we saw into equity funds in the late '90s, flows today vastly outstrip what we saw in the 1990s. That's true in absolute terms, but also in relative terms. 

So, just for starters, in the last five years or so, you've seen over $700 billion go into taxable-bond funds, and in the late' 90s, you saw about $650 billion go into U.S. equity funds. So in absolute terms there you do see a greater flow into taxable-bond funds. But also if you look at it on a year-by-year basis to see relative to the asset basis, relative to beginning assets, how flows are compared, again you've seen a greater percentage of flows go into taxable-bond funds than you had with equity funds in the late '90s.

Benz: So one thing you noted in the report, Kevin, though was that this doesn't appear to be necessarily performance-chasing, it's more that investors may simply be derisking their portfolios as they get closer to retirement, and also perhaps fear is it's still hanging over market participants in the wake of the bear market.

McDevitt: Right, in the late '90s, it definitely seemed to be more about greed rather than fear, and today perhaps that's reversed. Fear may be the more dominant emotion. I think what we worry about, we may get to this next, is that it doesn't necessarily mean there will be a better outcome for investors given that they're reacting out of fear rather than greed, but maybe more than a second.

I think as you pointed out this time around it's been more investors pulling money out of equity funds, perhaps they cut risk in their portfolios, while also pulling money from money markets funds and shifting that money into bond funds, perhaps looking for greater yield than they're getting on money market accounts which are essentially close to zero at this point.

Again, mentioning before that we've had over $700 billion go into taxable-bond funds, during that same time--just since January of 2009--we had over $700 billion go into taxable-bond funds. During that same timeframe, you've had $1.4 trillion leave both U.S. stock funds and money market funds. So it's not necessarily that you are seeing new contributions, new money going into taxable-bond funds, money has been pulled from other areas. Again that's a real contrast versus what we saw in the '90s, where there wasn't necessarily money being pulled from bond funds or money market funds to go into equity. These were new contributions. One point we make in the report is you actually saw a similar level of contributions going into money market funds, more than $600 billion from '95 to 2000, as you saw go into equity funds. You had about $650 billion go into equity, and I believe about $630 billion go into money market funds.

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Benz: Kevin, now I would like to switch gears a little bit. You mentioned some of the outflows we have seen from equity funds, and you have recently done some work where you actually drill into those statistics. Actually you trace the outflows from stock funds in no small part to a single fund. What is that fund?

McDevitt: It's American Funds Growth Fund of America, a fund we've certainly talked about and the largest actively managed fund. In fact, I think the largest U.S.-stock fund period is Growth Fund of America still to this day at about $130 billion in assets. That fund has been suffering outflows the last three years, really since the beginning of January 2009 and outflows ever since then. Because of the level of outflows, it has really kind of distorted the overall picture in terms of what we're seeing for actively managed U.S.-stock funds, and just to give a few examples, it's a large-growth fund. In the large-growth category during the past year, we've seen outflows of about $49 billion, but Growth Fund of America alone accounts for $39 billion of that. So, if you took Growth Fund of America out of the picture, really the outflows out of large-cap growth funds haven't been that severe. Now granted you're talking about the largest fund, so of course it's always going to have a big impact in any category you're talking about, but really there's no other fund that's close to Growth Fund of America in terms of outflows; again $39 billion over the last 12 months. The next runner-up has only about $8 billion in outflows, so really there's a huge gap between that fund and every other fund.

Benz: How has that affected GFA's performance? Has the fund begun to see performance slump as a result of those redemptions?

McDevitt: That's a great question, and it's always really difficult to kind of make those connections. I'm sure it's had some impact, but we were just actually out visiting American Funds a couple weeks ago, and we asked one of the managers that same question. He gave an answer that in some respects could be considered self-serving, but I thought it actually had some good merit to it.

He said that, well, given the fact that most redemptions have come since March of 2009, and since March of 2009 really the market has rallied quite well, albeit with several notable corrections mixed in there. But really [the fund shop] has been having to sell securities into a rising equity market, or at least a fairly healthy equity market. So, that's far preferrable to having to sell into a declining market. 

Benz: That's usually the more typical scenario that we see where investors are yanking their money at a time when the securities in a portfolio are super depressed and the manager usually doesn't want to be selling?

McDevitt: Right. Then you have liquidity issues, you've trading issues, and perhaps have to sell things you don't want to sell otherwise. But I think, in this case, there is an argument to be made for Growth Fund of America [in that if you're] going to have redemptions this is a pretty good environment in which to have them. That said, performance has been poor; over the last three and five years, the fund has performed very poorly in the bottom quartile, I believe, over the last five years. And I think some of that might be due to redemptions, but I think it's more due to the fact that that fund has had a pretty big and growing stake in foreign markets, in foreign equities, and those have been really out of favor relative to U.S. stocks over the last five years. So, I think that's been a real drag on the fund.

Benz: Let's look at the opposite end of the spectrum, Kevin, one firm that has been quietly gathering a lot of assets even in its domestic-equity funds is JPMorgan, and yet it's one that we haven't discussed too much. Let's talk about what's been going on there? Which funds have been gathering the assets and what you think is driving that?

McDevitt: Right. JPMorgan has had great growth. In the recent years, its asset base has roughly grown by 2.5 times over the last three years, I believe, up to about $150 billion to $160 billion in overall assets, and a lot of that has been driven naturally by performance.

You mentioned its equity funds; three of their five best-selling funds over the last 12 months have been actively managed equity funds, which have been, as you mentioned, one of the least popular areas generally speaking with investors. So the fact that some of [the firm's] most in-demand funds are actively managed equity funds really says something, and those funds have had great performance though.

JPMorgan Equity Income and the firm's U.S. Core, and Large Cap funds have all had very strong performance and strong inflows too as a result. JPMorgan is also seeing good flows into, as you might imagine, its bond funds, and the firm also has been fairly active in terms of bringing out new funds in recent years. I believe since early 2010, JPMorgan has come out with about 15 new funds, and frankly a few of these are fairly trendy in terms of which areas they're targeting. JPMorgan has a long-short equity fund. It has a currency fund and a real estate fund, I believe, as well. So, [these are] areas which are popular with investors, and you kind of worry that they're perhaps chasing trends to some extent.

Benz: Right. Well, Kevin, it's always great to hear from you and examine this intersection between investor behavior and fund performance and fund flows. Thank you so much for joining me.

McDevitt: Great. Thank you, Christine.

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