20
Predictions of a much-anticipated “Great Rotation”
of assets from bonds into equities have fallen
flat so far in
2014
. Despite the Federal Reserve’s
unwinding of its bond-buying program—at this
point projected to be complete in October—long-
term bond yields have fallen, with the
10
-year
down to
2
.
6%
as of July
31
from more than
3%
at the end of
2013
. Meanwhile, flows to fixed-
income mutual funds are solidly in positive territory
for the year to date, with taxable funds raking
in more than
$60
billion through June and munis
up
$11
billion over the same period.
However, there has been a smaller but still-important
shift in the makeup of the bond-fund universe. That
move was on display in
2013
as close to
$110
billion
in assets flowed out of traditional, “core” categories,
while about the same amount flowed into the non-
traditional-bond and bank-loan categories. And the
trend has continued into
2014
, with a slight twist.
Intermediate-term bond flows turned positive in the
first half of the year, but the heaviest flows have
surged into non-traditional-bond funds, while the multi-
sector and high-yield categories also took in mean-
ingful sums.
These flows are part of a broader, multiyear trend
that has left Morningstar’s taxable-bond universe
looking quite a bit different from how it did in
the runup to the credit crisis. As the taxable fund
universe nearly doubled from year-end
2007
through mid-
2014
, all categories saw growth, but
investors have increasingly favored funds outside
the traditional core universe of intermediate-term
bond and intermediate-term government funds.
Intermediate-term bond funds took in huge flows
in the years right after the credit crisis but are still
down to
36%
of the universe from
43%
in
2007
;
intermediate-term government funds have gone to
4%
from
8%
over the same period.
Quite a lot of money is flowing to funds with high
levels of credit risk. The bank-loan, high-yield,
multisector, emerging-markets, and non-traditional-
bond categories accounted for roughly
23%
of
assets in
2007
, but by June
2014
, their share of
taxable-bond dollars was up to
32%
.
What’s driving these flows isn’t a mystery. With
bond yields low, investors have had to look harder to
find income. It’s hard to remember, but the yield/
maturity on the Lehman U.S. Aggregate Bond Index
(now Barclays) stood at close to
5%
in December
2007
; it was a paltry
2
.
3%
by July
2014
.
Meanwhile, those rock-bottom levels, and the occa-
sional encouraging economic signal, have left
many anticipating an impending spike in bond yields
though rates remain stubbornly low. But this shift
comes with its own risks. The fastest-growing cate-
gories are also those with the most credit risk and
the highest correlations to equities. Investors relying
on the likes of non-traditional-bond and high-yield
funds to provide ballast in turbulent equity markets
could be in for a nasty surprise; junk-bond funds
lost more than
25%
on average in
2008
as did bank-
loan offerings, and, while most non-traditional-bond
funds haven’t been around that long, they suffered
losses in
2011
’s third quarter equity sell-off. Indeed,
the only categories in Morningstar’s taxable-bond
universe with negative correlations to the S
&
P
500
Index over the past three years are the government
and long-term bond categories. (Intermediate-term
and inflation-protected bond funds have very low
correlations.) Credit spreads are also tight, so it’s hard
to argue that junk bonds and other credit-sensitive
investments are a screaming bargain.
What’s the take-away for investors? Those entranced
by the yield offered in some of the racier bond
categories should expect—and plan for—these funds
to add equity sensitivity to their portfolios. And,
as always, it’s important to know what you own.
œ
Contact Sarah Bush at
Funds With Big Yields Are Tempting but
Treacherous
Income Strategist
|
Sarah Bush
