Are bond fund investors running toward a cliff?

Are bond fund investors running toward a cliff?
$5.3 billion flows into bond mutual funds in first week of June, even as yields continue to rise
JUN 12, 2015
Bond fund investors are chasing the wrong rabbit, and heading directly toward big trouble, according to David Santschi, chief executive of TrimTabs Investment Research. Citing the $5.3 billion that has flowed into bond mutual funds and ETFs during the first week of June, even as those same funds collectively declined by nearly 1% over the same period, Mr. Santschi said investors are ignoring market logic. “The asset flows are very shocking given the magnitude of the losses we've seen in bonds,” he said. “Given the back up in yields, we would expect investors to be selling pretty hard right now.” Through June 5, the yield on the benchmark 10-year Treasury had increased by 55 basis points to 2.40%, from 1.85% on April 17. By mid-day Tuesday, the yield was at 2.43%. The price of bonds fall as yields rise. Mr. Santschi is surprised by the move by bond-fund investors, considering the reaction to the so-called “taper tantrum” in May 2013, when yields spiked on news that the Federal Reserve was planning to dial back its multi-trillion-dollar bond-buying program. “The contrast between what's happening now and what happened amid the taper tantrum has been dramatic,” he said. “The yield on the 10-year note rose 80 basis points in May and June of 2013, which helped trigger the record outflow of $68.6 billion from bond funds in June of that year.” A CERTAIN LOGIC But, while Mr. Santschi believes there is “too much complacency in the bond market,” others are seeing a certain logic to the move by yield-hungry investors. “I'm not sure that we should be surprised about a surge in investment flows in an asset where lower prices means higher yields,” said Scott Colyer, chief executive at Advisors Asset Management. “The macro story remains clear to us: Investors are voting against equity risk in favor of bond risk, not just over the short term but over extended periods,” he added. “Investors need income and have always believed there is less risk to their principal in bonds versus stocks.” Steven Wruble, chief investment officer at RiskX Investments, agrees that the flows into bond funds suggest investors are becoming less comfortable in the equity markets. “Right now the Fed is saying they don't know what they're doing with rates, and investors are saying they don't think rates are going higher,” he said. “To me, it says, either retail investors are a lot smarter than all the economists out there, or they're just feeling uneasy about equities, and bonds are seen as the next best alternative.” The long-term perspective is also the view of David Mendels, director of planning at Creative Financial Concepts. “I don't do market timing and I don't try to anticipate what rates will do next,” he said. “And I can imagine people are seeing that they are starting to get a few more basis points in bonds right now.” Todd Rosenbluth, director of mutual fund and ETF research at S&P Capital IQ, also believes the flow data should be considered in the context of a longer-term perspective. “Mutual fund investors tend to be more long-term focused and are unlikely to be fazed by the ultra-short term performance in their investments,” he said. “We think a prolonged decline in mutual fund performance would be needed to cause investors to make significant changes to their asset allocation strategies.” Viewing fund flows as contra-indicators, Mr. Santschi believes bond yields will continue to rise until investors start to change course. “If investors were selling bond funds aggressively, we would expect yields to top out or go lower,” he said. “The question now is how high will yields have to go before people start to care, because the fact fund investors aren't bailing out suggests that yields have further to rise.”

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