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Bond Funds Continue to Shine


Equity mutual funds are experiencing a resurgence in the first month of the new year. But investors continue to pour money into bond funds, as interest-rates remain low fpr the foreseeable future.

Investors poured slightly more than $300 million into taxable and municipal bond funds in 2012, according to Investment Company Institute counts. That was more than double the $124.1 billion pulled in a year earlier.

Lipper estimates that bond funds raked in $257 billion in assets last year, eclipsing 2011's total of $132 billion but short of the $325 billion that flowed into bond funds in 2009.

"Bond funds surprised us last year by compounding 2011's numbers by another $120 billion," said Jeff Tjornehoj, Head of Lipper Americas Research. "We've been seeing lighter trends in the taxable bond funds since 2009; that was the high water mark. A lot of that has to do with more uncertainty in the market whether it was concerns about the euro or the fiscal cliff. As a consequence we saw investors remain committed to fixed income."

According to Tjornehoj, while equity mutual fund investors poured another $3.7 billion into equity funds for the week ended January 23, investors also pumped another $3.5 billion into taxable fixed income mutual funds. In fact, $13.2 billion flowed into bonds funds in the first three weeks January compared to $10.2 billion during the same period in 2012.

"The story in the first couple of weeks of the year has been about the very strong flows of equity funds and how they've gathered more in the first three weeks than any other three-week period going back to 2001," said Tjornehoj.

"But I don't think that's really detracted from fixed income flows. We're still seeing weekly flows hit that $3.5 billion mark. That's a pretty good number and I think it reflects how there's been a demographic shift in the U.S. over the last several years as baby boomers age. Generally speaking, I don't think they're willing to go back into equity-focused investing," he said.

However, Tjornehoj warned against reading too much into last month's fixed-income tally. "January is often a pretty good month for flows," he said. "People are creating resolutions. Maybe you got hired in the third and fourth quarter of 2012 and wanted to start socking money away in January."

While 2013 may be another good year for fixed income funds, Tjornehoj doesn't think they will surpass their own inflow numbers for 2012 because of fears of interest rates eventually rising in the near future. Rather, he predicts somewhere in the neighborhood of between $125 billion to $150 billion will flow into bond mutual funds this year, much like 2011.

Although total bond fund inflows may be hard to predict, it's not a stretch to say that the asset class will be getting its fair share of inflows this year. That's because the Federal Open Market Committee, a committee within the Federal Reserve System charged with overseeing the nation's open market operations has "decided to keep the target range for the federal funds rate at 0 to .25% and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5%," according to a statement from the Federal Reserve in December 2012.

That's good news for bonds funds because of the inverse relationship between bond funds and interest rates: When interest rates rise, the value of a bond falls in value.

And according to the Bureau of Labor Statistics, the national unemployment rate in December was 7.8%, down from 8.3% a year earlier. But that still exceeds the 6.5% level that the Fed holds as a threshold to alter rates.

Bond fund managers are cautiously optimistic that investors will continue to buy up their wares this year. Ed Fitzpatrick, fund manager at Schroders, said investor sentiment has favored credit funds in the last few years because of a high level of uncertainty around domestic and international politics.

While Fitzpatrick doesn't expect to see the same level of assets flowing into bond funds this year versus last year, he anticipates continuing flows intothe asset class. "It would be difficult to envision a situation where that pace of flows continues but right now we don't expect significant outflows out of credit and into equity," said Fitzpatrick.

"Given the fiscal austerity and payroll tax hikes, the growth prospect in 2013 is not going to be quite as robust as the market anticipates right now. We anticipate that the Fed will remain on hold for all of 2013,'' he said. ''In this low-growth environment, this is a backdrop that can still be supportive of credit strategies."

Brendan White, portfolio manager of the Touchstone High Yield Bond Fund (THYAX), echoes the same sentiment. "I think flows will slow a little but it'll remain robust because there's a real lack of alternatives out there," he said.

"If you're looking at high-grade fixed income funds, there's a chance of negative returns if interest rates rise,'' White said. "Equities will continue to attract dollars and some of those dollars will come from what would've gone to high-yield or high-grade funds. We'll continue to see strong flows going into high-yield but not at the levels we saw last year."


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