The summer plunge of interest rates drove yield-hungry investors into bond mutual funds in record numbers in July, and many fund companies say the boom has continued in August.
But the desperate hunt for yield is again raising fears that novice investors are ignoring the risks inherent in bonds--and creating a time bomb for the fund industry.
Meanwhile, investors also are frantically pouring money into international stock funds--another fund sector that is performing well now but whose greater-than-average risk may not be apparent to new investors.
The Investment Company Institute, chief trade group for the fund industry, said Monday that net new cash flow into bond funds reached a record $13 billion in July, surpassing the prior record of $12.8 billion in January, 1987.
Stock fund net new cash flow hit $9.7 billion in July and, while not a record, was up from $9.2 billion in June. Net new cash flow measures the fresh cash deposited in funds, after redemptions and exchanges.
This month, fund companies including Franklin Group, Prudential, Fidelity and T. Rowe Price said overall fund purchases are close to July’s pace or surpassing it--a surprise for a month in which Americans usually focus on leisure, not personal finance. “Nobody took a vacation this year,” joked Jessica Bibliowicz, marketing director for Prudential’s mutual funds.
In July, the sharp drop in long-term interest rates--while money market rates held at 30-year lows--apparently forced more investors into longer-term bonds in attempts to lock in a decent yield, experts say.
And this month, purchases of tax-exempt municipal bond funds surged after Congress passed President Clinton’s budget plan, which raised income tax rates.
Although muni funds already are the single biggest fund category, investors in higher tax brackets suddenly found munis even more attractive given the Clinton tax hikes.
But the continuing heavy migration of cash into bond funds is a source of renewed worry for the fund industry, which fears that novice investors are unaware of the risks in bonds. If interest rates begin to rise, bond fund share prices will slide, and that could spark a mad scramble out of bond funds that would rival the current scramble into them.
However, most fund companies say new investor purchases of bond funds are concentrated in shorter-term and intermediate-term funds, which typically own bonds maturing in one to seven years. Those bonds don’t yield as much as longer-term issues, but neither will they lose as much value if market interest rates jump.
The Vanguard Group of funds says that 65% of its bond fund purchases this month are in short and intermediate funds. Fidelity says those funds account for more than 80% of bond fund purchases.
Experts caution that while shorter-term bond funds are less vulnerable to rising rates, they would still suffer somewhat. What is unknown is new investors’ pain threshold should the market turn.
“We hope they’ve read (about the risks) and are prepared to deal with it,” said Vanguard spokesman Brian Mattes.
There is less concern in the industry about investors’ new hunger for international stock funds, which also can be volatile. While many fund companies report sluggish interest in U.S. stock funds this summer, international fund purchases are soaring.
T. Rowe Price said its international fund purchases have accounted for 87% of total stock fund purchases this month. At Fidelity, international fund purchases tripled between July and August.
Experts say investors are in part responding to gains in most foreign stock markets this year: Fast growth naturally gets attention.
But many investors may simply be heeding the advice of market pros, who for years have said the greatest opportunities for the ‘90s are overseas.
The Most-Owned Funds
Investors have put an unprecedented amount of money into stock and bond funds over the last year, sending fund assets soaring. The largest fund categories now, in billions: Muni bond: $234 Growth & Income stock: $206 Treasury/GNMA bond: $192 Growth stock: $156 Aggressive growth stock: $103 Mixed bond: $94 International stock: $68 Source: Investment Company Institute