Most New Dollars Go to Bond, Money Funds
Stock mutual funds are attracting the bulk of fund investors’ new dollars this year, right?
Not right.
As hot as stock funds have been, fund investors overall have poured almost $20 billion more into bond and money market funds this year than into stock funds.
Net new cash flow--new purchases less redemptions and exchanges--into bond and money funds totaled $126.2 billion through May, while stock funds’ net new cash flow in that period was $106.5 billion, the Investment Company Institute reported this week.
By contrast, in the first five months of 1997, stock funds took in $92 billion, more than double the $41 billion that flowed into bond and money funds.
While the bulk of this year’s income-fund cash flow ($83 billion) has gone to money funds--which function as checking accounts for some investors, and thus aren’t necessarily considered investments--bond funds still are more popular these days than at any time since the mid-1990s.
The conventional wisdom is that many investors are pumping money into bond funds to hedge their bets on the high-flying stock market.
Bonds, after all, pay a set rate of interest and thus are viewed as far less risky, overall, than stocks, whose value today depends far more on investors’ collective psychology than on any cash dividends the shares may pay.
So if the stock market dives, many investors may be figuring, the price of their bond fund shares should hold up reasonably well.
That isn’t a bad assumption with most bond fund categories. But there’s a problem here: The most popular bond fund category in recent years has been “junk”--high-yield corporate bonds issued by companies considered less than investment grade.
And junk bonds, historically, have not been a good place to be invested if the stock market is falling because of worries about the economy’s health.
Data from the ICI show just how hungry investors have been for junk bond funds in recent years, versus for other bond and income fund categories:
* From 1996 through May, junk funds took in net new cash flow of $38.98 billion, the ICI says. The funds’ total assets as of May 31: $120 billion.
* Strategic income funds--a category that includes so-called multisector funds that also usually invest heavily in junk bonds--took in $23.49 billion over the same 29-month period.
* While inflows into junk and strategic-income funds have soared, funds that own long-term U.S. government bonds have seen cash flow out rather than in. A net $11.18 billion has been pulled from those funds since 1996, reducing the category’s assets to $35.5 billion, ICI says.
* Likewise, investors have on balance yanked cash from mortgage-backed bond funds, such as those that invest in Government National Mortgage Assn. bonds. Those funds have seen $9.87 billion flow out since 1996.
The trends beg the question: Are bond-fund buyers simply going for the highest-yielding funds, rather than choosing the most appropriate type of bond “hedge” for their total portfolios?
Fund company executives concede that there has been a “reach for yield” on the part of many fund investors.
“I think yield continues to drive fixed-income fund sales, as it has for some time,” said Edward D’Alelio, chief of corporate fixed-income for fund giant Putnam Investments in Boston.
But he believes that most bond-fund buyers still are basically on the right track in seeking to diversify their portfolios, which for many investors have become excessively stock-heavy in the wake of Wall Street’s unprecedented three-year surge.
What’s more, the outflows from government-bond funds may not indicate that investors are abandoning those securities, experts say. Rather, because U.S. Treasury securities can easily be purchased individually--and held to maturity, with no credit risk--many investors may be going that route instead of buying government-bond funds, analysts note.
Still, experts caution that if the economy should start to slow significantly--raising the risk of a surge in defaults by junk-bond-issuing companies--investors who thought they had a good hedge for their stock portfolios might discover instead that their junk bond funds are sinking with stocks--even if other types of bonds rise in value, assuming that a slower economy brings lower interest rates.
