is a bond fund exodus beginning?

money is starting to flow out of bond funds

The Investment Company Institute, the trade organization of the the mutual fund industry, reported on Tuesday its weekly estimate of the money flowing in and out of the industry’s products.  The current report covers the week ending December 15th.

The equity news is the same as it has been for a long while–investors are taking $2 billion or so out of domestically-oriented funds each week and putting a somewhat smaller amount into foreign/global funds.

The real changes are coming on the bond side, both taxable and tax-exempt.

Over the past month or so, municipal bond funds have lost a total of $14 billion to net redemptions, presumably on worries about credit quality

For the past two weeks, for the first time since the collapse of Lehman in late 2008, taxable bond funds have had sizable withdrawals–$1.3 billion in the period ending 12/8 and $4.9 billion in the week of 12/15.

Why is this happening?

Bond yields are rising, as investors sense that the worse cyclical effects of the financial crisis are behind us.  Economic indicators and corporate reports are suggesting the US economy is stronger than the consensus had thought.  Markets are concluding that we’re past the cyclical lows for interest rates and that the Fed may begin to restore a normal (read: higher) level of rates sooner rather than later.

This means bond funds are potentially facing a headwind that will likely produce capital losses.

Where is the money going?

That’s not clear.  Some mutual fund consultants, like EFPR of Cambridge, Massachusetts, say the bond fund withdrawal money is going into equity funds.  Others are suggesting that it’s being parked on the sidelines in money market funds.

The ICI data, which cover the entire US mutual fund industry, don’t show either.

The ICI releases a separate weekly report on money market fund assets. That shows money market fund assets as being flat since the beginning of the month.  Assets held by retail investors are actually up slightly.

As mentioned above, the ICI data have shown a continuing small loss of money from equity funds over the past couple of years.  There’s a sharp shift within the equity category from US to non-US, but a net drain nonetheless.  That hasn’t changed.

So where is the money going?

A Bloomberg article that talks about he ICI numbers speculates that some is going into direct purchases of bonds.  This makes some sense:  you avoid the management fee mutual funds charge; and, unlike funds, individual government bonds mature–and you get your principal back.  I  suspect this is being done by individuals, not the institutions the article suggests, however.

I think a large chunk of this “lost” money will eventually end up in the stock market, either through individual equity purchases or stock ETFs.  Why?  Historical patterns suggest stocks are flat to up during a cyclical rise in interest rates, while bonds fall.  Also, to the extent that customers are withdrawing money from load mutual fund organizations–and Bloomberg suggests this is happening at places like Pimco–and forfeiting the sales charges they have paid, this suggests a certain finality to their actions.  My guess is that such investors are taking out a fresh sheet of paper and rethinking their asset allocations.

If so, we should see evidence of a more equity-friendly attitude as the new year begins.  Given that taxable investors typically greet January by selling winners they have nursed into the new tax year, a large inflow of new money should be easy to detect.






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