Investors have once again taken a liking to taxable bond funds, which have experienced positive flows of $19.2 billion so far in 2016. Advisers may find that their clients are taking notice, too.
This year’s strong performance is a marked difference from last year, when, after 14 consecutive annual net inflows, these funds suffered net outflows of over $101 billion.
Net inflows into taxable bond funds were strongest in the four-year period after the financial crisis, when the Federal Reserve drastically reduced interest rates, and investors were searching for alternatives to the equity market.
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Fixed income has posted steady returns in these markets, while once high-flying equities have come crashing down.
June 29 -
Fixed-income yields may feel low, but foreign investors facing negative yields at home are making the U.S. markets popular.
June 6
Fund flow results for taxable bond funds came back to earth in 2013 and 2014, when equity funds posted combined net inflows of $271 billion.
The slump for taxable bond funds began during the second half of 2015. The group suffered all of its net outflows for the year (-$124.8 billion) during the last two quarters, and, on average, posted returns of -1.9%.
The worst returns among the fund group had a focus on risky assets. Funds in Lipper’s emerging markets local currency debt funds category had the lowest average returns of the group, retreating 10.4%. The next three lowest returns for the second half of 2015 all belonged to high-risk classifications: high-yield funds (-6.1%), emerging markets hard currency debt funds (-4.0%) and loan participation funds (-3.4%).
A RISK-OFF STRATEGY
This risk-off strategy was also evident in the fund-flows data for the third and fourth quarters of 2015. This quartet of high-risk categories accounted for approximately $40 billion in net outflows during that period, paced by high-yield funds, which saw their coffers shrink by $17.4 billion.
Net inflows into taxable bond funds were strongest in the four-year period after the financial crisis, when the Federal Reserve drastically reduced interest rates, and investors were searching for alternatives to the equity market.
This risk-off strategy was driven by market events. The Fed jawboned the markets for a good part of the year, as speculation around interest-rate hikes swirled. The Fed had not raised rates in almost a decade, and rates had been near zero since the start of 2009.
The Fed did manage to raise rates in mid-December, but they were prohibited from starting their rate-raising program earlier, due to global growth concerns and an extended decline in oil prices, both of which contributed to keeping the U.S. rate of inflation below the Fed’s target.
The exodus from higher-risk categories was fairly widespread during the second half of 2015, but some of the hardest-hit funds were Oppenheimer Senior Floating Rate Fund (-$2.4 billion), PIMCO Emerging Local Bond Fund (-$2.1 billion), PIMCO High Yield Fund (-$1.9 billion) and Fidelity Advisor Floating Rate High Income Fund (-$1.8 billion).
Interestingly, it was an investment-grade fund, PIMCO Total Return Fund, that experienced the largest negative flow (-$12.8 billion) during this time period. PIMCO Total Return has not yet seemed to recover from the turmoil prior to and after co-founder Bill Gross’ departure, as it has seen its AUM shrink to $86.4 billion from a peak of $292.7 billion in April 2013.
TRACKING A TURNAROUND
The slump for taxable bond funds continued into the first two months of 2016, but since that time, the group has taken in $39.1 billion in net new money. The turnaround that started in March was a direct result of Fed Chairwoman Janet Yellen giving a dovish speech that indicated the Fed would proceed cautiously regarding raising interest rates. Yellen explained that this was because U.S. inflation was not yet robust enough to protect the economy from risks around the globe.
The slump for taxable bond funds continued into the first two months of 2016, but since that time, the group has taken in $39.1 billion in net new money.
Yellen’s speech set off a turnaround in the taxable bond fund macro-group, which enabled them to post a +5.9% average return for the end of February through the end of July, in glaring contrast to the 1.9% loss the group suffered during the second half of 2015. Also in direct contrast to the end of last year, the best performance belonged to the categories that invest in the riskiest fixed-income sectors.
Emerging markets local currency debt funds posted the highest performance at +12.6%, followed closely by emerging markets hard currency debt funds (+11.2%) and high-yield funds (+10.2%). Loan participation funds were not far behind this group at +6.8%, ranking eight out of the 26 taxable bond categories. All 26 fixed-income groups posted positive returns for this time period.
Three investment-grade classifications have accounted for the lion’s share of the total net inflows for taxable bond funds (+$39.1 billion) since the end of February. Funds in Lipper’s core bond funds classification experienced net inflows of $25.6 billion during this time, while core plus bond funds and U.S. mortgage funds contributed $8 billion and $5.1 billion, respectively.
The taxable bond fund group bears watching during this second half of 2016. If the group is going to continue its four-month run of positive fund flows and returns, it will need to overcome the headwinds the Fed recently put out.
The increase in the core bond funds category was driven by funds from Vanguard. Vanguard Total Bond Market II Index Fund (+$7.6 billion), Vanguard Total Bond Market Index Fund (+$7.1 billion) and Vanguard Intermediate-Term Investment-Grade Fund (+$3.1 billion) were responsible for almost $18 billion of the net new money taken in by core bond funds.
The results for the core plus bond funds group were similarly concentrated, as a handful of funds accounted for the overwhelming majority of the positive flows. Metropolitan West Total Return Bond Fund, Bridge Builder Core Plus Bond Fund and Prudential Total Return Bond Fund had the largest net inflows for the group, at $4.5 billion, $2.1 billion and $2 billion, respectively.
The picture was even more concentrated for the U.S. mortgages group, as the DoubleLine Total Return Bond Fund, managed by Jeffrey Gundlach, was responsible for approximately 80% of net inflows into the classification, growing its coffers by $4 billion.
WATCHING THE FED
The taxable bond fund group bears watching during this second half of 2016. If the group is going to continue its four-month run of positive fund flows and returns, it will need to overcome the headwinds the Fed recently put out. Fed officials indicated in late July that they have not taken an interest rate hike off the table for its September meeting, stating that “near-term risks to the economic outlook have diminished.”
Key components to this possibility include equity markets stabilizing fairly rapidly after the surprise Brexit vote, and the U.S. economy showing some strength, as evidenced by the surprisingly robust June jobs report. There has been a direct correlation between Fed interest rate policy and taxable bond funds, so continued saber rattling by the Fed will likely have a negative impact on taxable bond funds.
