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Wednesday, December 09, 2009

Bond Fund Net Flows Creep Towards $400 Billion

Reported by Patricia Kelly

Investors continue to pour money into bond mutual funds, with expected full-year 2009 inflows inching towards nearly $400 billion –- an all-time high –- according to the latest estimates released Wednesday by Strategic Insight.

Bond funds' rapid growth has gained momentum from a 50 percent rise in new sales compared to last year, as investors are choosing bonds over stock and money market funds. Money market fund assets have decreased by approximately 15 percent this year.

“This has been the year of the bond fund. With $10 trillion held in cash throughout banks and retail market funds earning near zero yields, mutual fund shareholders have been slowly recovering from the traumas of 2008 by moving off the sidelines and into the higher yields of bond funds,” stated Avi Nachmany, Strategic Insight's director of research.

Specifically, investors are clamoring for taxable bond funds, including short- and intermediate-duration bond funds, which now account for over 80 percent of all bond mutual funds. Although taxable bond funds promise higher returns compared to other fixed-income products, investors' appetite for risk remains lukewarm at best.

“Stock markets around the world have rebounded dramatically. But this price recovery occurred in a background of modest redemptions out of US equity funds, and selected, at times speculative, buying of international and narrow global regions or sector funds,” stated Nachmany. “Clearly, fund investors' appetite for risk remains low. Search for income and low risk tolerance are likely to continue to dominate the fund landscape in early 2010, and maybe beyond. We expect little change to that dynamic until the employment and economic clouds start to clear.”

While US equity/hybrid funds have redeemed under one percent of their assets, international stock funds have witnessed impressive inflows, particularly to funds focused on emerging markets.

Aside from bond funds, the other star this year has been ETFs, which drew estimated net inflows of $110 billion in the full year 2009 – a figure slightly lower than 2008's all-time high but robust enough to push US ETF assets over a record $750 billion by the end of 2009.

Strategic Insight's year-end estimates are based on its Simfund database and its projections for December. While the data incorporates both traditional mutual funds and funds underlying variable annuities, it excludes ETFs.

NEW YORK, NY – December 9, 2009 – Led by robust demand for income as cash yields remain near zero, US investors’ use of bond mutual funds reached record levels in 2009. Strategic Insight, a business intelligence provider to the fund industry, estimates that full-year 2009 inflows to bond funds will come in at an all-time record of almost $400 billion – an impressive number considering bond and stock fund flows have never before topped $300 billion in one year.

Those figures mark a strong resumption of fund investing by U.S. households after the paralysis-induced shocks of 2008. SI’s projections for the full year are based on SI’s Simfund database and projections for December. (These figures include traditional mutual funds and funds underlying variable annuities, but exclude ETFs, which benefitted from over $100B of net inflows in 2009.)

More than 80% of bond fund flows have gone to taxable bond funds, including short- and intermediate-duration bond funds that appealed to investors seeking higher yields than those available in bank deposits or money-market mutual funds. The balance of flows went to tax-free bond funds, also led by shorter-duration products used for tax-exempt cash alternatives.

For the nearly $12 trillion US mutual fund industry, bond funds’ record growth was propelled by their new sales rising 50% from 2008’s pace (based on ICI tracking of such sales). Meanwhile, demand for stock funds has been subdued, and money market fund assets shrank by about 15%.

Estimated Stock & Bond Fund Flows: 2009 (in $B)

Taxable Bond 314

Tax-Free Bond 69

Total Bond Funds 383

Domestic Equity -34

International Equity 41

Total Equity Funds 7

Total Long Term Funds 390

“This has been the year of the bond fund. With $10 trillion held in cash throughout banks and retail money market funds earning near zero yields, mutual fund shareholders have been slowly recovering from the traumas of 2008 by moving off the sidelines and into the higher yields of bond funds,” commented Avi Nachmany, Strategic Insight’s Director of Research.

“Stock markets around the world have rebounded dramatically. But this price recovery occurred in a background of modest redemptions out of US equity funds, and selected, at times speculative, buying of international and narrow global regions or sector funds,” Nachmany said. “Clearly, fund investors’ appetite for risk remains low. Search for income and low risk tolerance are likely to continue to dominate the fund landscape in early 2010, and maybe beyond. We expect little change to that dynamic until the employment and economic clouds start to clear.”

Strategic Insight estimates that US equity/hybrid funds will have redeemed over $30 billion in all of 2009, under 1% of their assets. In contrast, inflows to international stock funds will have exceeded $40 billion in 2009, with more than half going to emerging markets as well as increasingly popular “global asset allocation” funds. Emerging markets’ 70%+ returns year to date have drawn investors, with such gains partly supported by US dollar depreciation. Overall, international funds benefit from US investors increasing the global diversification of their investments, a long-term secular trend that paused in 2008 due to the financial crisis.

After adding more $600 billion to money market mutual funds in both 2007 and 2008, this year money fund flows reversed and such funds are estimated to have seen net outflows exceeding $500 billion in 2009. Clearly, institutional investors and some individuals withdrew a portion of the assets they’d put into money funds in 2007 and 2008 as safe havens, and instead in 2009 sought alternatives to the near-zero yields that many of these funds offered.

Separately, Strategic Insight estimated that US Exchange Traded Funds (ETFs) drew net inflows of $110 billion in the full year 2009. While that figure (which includes ETNs) is short of the record inflows of $176 billion that ETFs enjoyed in 2008, such inflows for 2009 will likely bring U.S. ETF assets past $750 billion at year-end, setting a record for ETF asset totals. (Worldwide, ETF assets now exceed $1 trillion.) Much like traditional mutual funds, ETF flows during 2009 were driven mostly by taxable bond ETFs and international equity ETFs, which together accounted for roughly 70% of all ETF net inflows.

“Coming after the surge in ETF growth in 2008, this year’s continuing momentum for ETFs marks a maturing of the space. The diversity of the ETF marketplace allows for growth when markets decline as well as when they rebound,” said SI senior research analyst Loren Fox. “Given what we’ve seen, it’s possible that U.S. ETF assets will hit the $1 trillion mark in 2010 or 2011.”

Across all industry segments, including ETFs, stock and bond fund assets increased by over $2 trillion in 2009, benefitting from strong NAV appreciation during 2009 and from record bond fund inflows. Such a yearly increase in managed assets was the largest in the fund industry’s history (the prior record of annual asset gains occurred in 2003 when long-term fund assets increased by $1.36 trillion). Yet, even with such dramatic rebound in 2009, stock and bond fund asset are still $1.3 trillion below their levels at year-end 2007.

* * *

In its 23rd year, Strategic Insight is a research firm for the mutual fund and wealth management industry, providing clients with in-depth studies, consultation, and electronic decision support systems. Strategic Insight, an Asset International company, assists more than 250 organizations worldwide, including the largest mutual fund managers in the U.S. and the largest insurance companies serving the VA business. For more information, visit our home at www.sionline.com. 

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