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Rate-Hike Fears Not Causing Investors to Shun Bonds

Jeremy Glaser
Timothy Strauts

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Tim Strauts--he is the senior markets research analyst at Morningstar. We're going to look at February's asset-flows data and see what trends are emerging.

Tim, thanks for joining me.

Tim Strauts: Thanks for having me.

Glaser: Let's start in fixed income. There were inflows into that space throughout the month. Could you talk a little bit about where that money was going?

Strauts: Taxable bond was the largest-flowing category. And among taxable-bond funds, it was high-yield and intermediate-term bonds that got the most money.

Glaser: Why do you think investors were interested in high yield during the month?

Strauts: The Federal Reserve has been signaling that they may raise interest rates as soon as June, and high-yield bonds tend to do well in a rising-interest-rate environment. So, if investors are anticipating this move, they may move into the high-yield category.

Glaser: And does that seem like a prudent move to move into a high yield right now?

Strauts: Theoretically, high-yield bonds are more insulated from interest rates because of their higher coupon payments, but a lot of the high-yield bond funds have a larger exposure to oil companies. And as we know, the price of oil has dropped, so there might be a little more volatility in high-yield bond funds going forward.

Glaser: Then, how do you explain the flows into intermediate-term bonds? If we are worried about rising rates, that wouldn't seem to be a safe heaven.

Strauts: That's actually an interesting question, because I don't know why all the money is flowing into intermediate-term bonds. There may be a subset of investors that doesn't think rates are going to rise, and [in that case,] intermediate-term bonds are a good place to be. But if you think interest rates are going to rise, intermediate-term bonds are not going to be the best-performing taxable-bond category.

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Glaser:  We've been tracking the outflows from the largest intermediate-term bond fund, PIMCO Total Return (PTTRX), since Bill Gross' departure. Any updates on that?

Strauts: In February, the fund lost another $8.9 billion, for a total of $99.4 billion in the last six months, which is just an amazing number. We've never seen outflows of this size in any fund ever. Right now, the fund only has $124 billion in assets. So, the pace of outflows has to slow down if the fund is even going to be around in another year. We would expect the flows to slow down in the next few months, but I would say it is starting to get concerning, the pace of outflows.

Glaser: Has the pace slowed at all over the past couple of months?

Strauts: It has. The December outflow was $18 billion. January was $12 billion. And as I said, February was around $8.9 billion.

Glaser: Is there any change in where that money is going, or is it the same usual suspects?

Strauts: It's the same usual suspects; MetWest Total Return Bond (MWTRX) got most of the money, and actually that fund has now doubled in size in the last 12 months. So, it's the clear winner when it comes to getting the PIMCO Total Return funds.

Glaser: Next, let's look at equities. There were some inflows into foreign stocks during the month. Where are U.S. investors placing their bets abroad?

Strauts: The two biggest categories were foreign large blend and Europe stock, and we think that both categories are due to the European Central Bank's quantitative-easing moves to lower interest rates. Since the announcement, they've really kind of created a stock market rally in Europe. And in general, we think that U.S. investors are looking at the U.S. market and saying, "Well, we've had a really good run over the last six years, and maybe it's time to start reallocating some of the money out of the U.S. and into some of these cheaper international markets."

Glaser: When you buy those international funds, currency becomes a major issue, with the euro falling so much against the dollars. How is that impacting investment choices?

Strauts: Traditionally, investors have not done any currency hedging with their international investments. They have bought the international funds, and if the currency goes up and down, that just affects your returns. But more recently, some ETFs have come out that actually hedge this currency risk for you, and the biggest one right now is WisdomTree Europe Hedged Equity (HEDJ). It's an ETF that hedges out the currency risk to the euro, which has been a really good idea lately because the euro has been dropping so dramatically versus the dollar. So, since they hedge out that risk, [investors have] actually been able to take advantage of the strong stock market rally in Europe.

Glaser: How much has flowed into that fund?

Strauts: Just last month, it was $2.3 billion, and the fund has doubled in size just in the last three to four months.

Glaser: Tim, thanks for the update on asset flows today.

Strauts: Thanks for having me.

Glaser: For Morningstar, I'm Jeremey Glaser. Thanks for watching.

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