Bond fund investors say goodbye to 2013

Amid the sounds of “Auld Lang Syne” and shouts of “Happy New Year!” at the start of 2014 was a sigh of relief from bond fund investors that 2013 was finally over.

It was a rough year. The benchmark Barclays U.S. Aggregate Bond Index fell 2.02%, and prices failed to recover from a beating in the second quarter on fears about the Federal Reserve’s prospective tapering.

From a fund flows perspective, investors were still generally uneasy enough about bond exchange-traded funds to continue pulling money from them. In fact, there was $4.5 billion in net outflows in the fourth quarter as Treasury-related products bled assets.

Hardest hit was the iShares 3-7 Year Treasury Bond ETF (IEI), which had net outflows of $2.7 billion in the quarter and led its General U.S. Treasury Funds classification, which had net outflows of $4 billion. Investors walked away from all kinds of Treasury-related strategies, from inflation-related types such to generally less volatile short-duration plays.

But they didn’t turn their backs on all bond fund types.

As the stock market roared to life in the final three months of the year and pushed past old resistance levels, ETF investors piled $1.7 billion net into junk bond products. The group’s top draw, the SPDR Barclays High Yield Bond (JNK), took in an estimated $623 million net, while slightly more-risk-averse investors plowed about $581 million net into the SPDR Barclays Short Term High Yield Bond (SJNK), whose duration is half as long as JNK’s.

ETF products in Lipper Inc.’s Core Bond Funds classification also had sizable ($1.4 billion) net inflows in the quarter, led by popular iShares Core Total U.S. Bond Market (AGG), with $884 million in estimated net inflows, and Vanguard Total Bond Market Index (BND), with $756 million. The latter, with $17.6 billion in assets, is the largest bond ETF in America, while the former sits in third place, with assets of $15.4 billion.

NET OUTFLOWS

Some peers in that classification, such as the iShares Intermediate Credit Bond (CIU), faced net outflows, which brought total net inflows to the group down a bit.

Returns also varied.

As is typical each quarter, a specialized leveraged product had the best return. Filtering out such strategic outliers shows that a few performance trends confirmed the outflow activity.

First, junk bond products clearly held the edge in performance as they did in flows, with the top spot going to the Market Vectors International High Yield Bond (IHY), which had a fourth-quarter return of 4.04%, slightly better than the return on second-place JNK (3.63%).

Overall, the High Yield Funds group had a quarterly return of 3.39% on average, well ahead of the 1.74% average return put up by the next-best group, International Income Funds.

Second, just as the net-outflows patterns suggested, the quarter’s worst performance was found among ETFs in the General U.S. Treasury Funds group, which had a quarterly loss of 2.15% on average. The six worst-performing classifications were all Treasury-, agency- or mortgage-related strategies and were led to the bottom of the performance tables by Vanguard Extended Duration Treasury Index (EDV), which lost 5.26% during the quarter.

Through a combination of disappointing performance and investor withdrawals, the bond ETF industry is today $25 billion smaller than at its peak asset level in May 2013, when then-Fed Chairman Ben S. Bernanke famously hinted at tapering. Since the Fed actually began tapering in December, ETF investors have been reluctant to build on their investments out of fear that rates have further reason to roam higher.

Jeff Tjornehoj is head of Americas research at Lipper Inc.