Following the flows
The other day, I ran across a strategy piece from a US asset manager commenting on the latest mutual fund flows. Investors took money from equity funds in September at the fastest rate this year, while bond funds continued to attract cash. This prompted me to take a closer look myself. Global mutual fund flows for the last four years have favoured bond funds to a quite staggering extent. Data from Cerulli Associates confirmed that bond funds have outsold equities every year since 2008, and showed two major spikes in bond sales in 2009 and 2010.
For an investor today, the annual yield of 1.6% on 10-year US Treasuries (or 1.7% on 10-year gilts) will not transform into a successful long-term investment any more than the alchemist can turn base metal into gold. If you take inflation into account the yield on core government bonds is virtually zero and yet money flows continue unabated into fixed income products. It is true that many of these are flexible bond funds, which are not restricted to government issues. However, yields on credit have fallen dramatically too. The yield on the Barclays US Investment Grade Index fell to a record low of 2.7% in October.
And yet equities are outperforming, despite being shunned. From 31/12/08 through to 31/10/12 the S&P 500 Index gave a total return of 69.8% (14.8% annualised)¹. By contrast, the Barclays Capital US Aggregate Bond Index returned 26.8% over the same period (6.4% annualised)². Even though financial markets remain uncertain, I would have expected some reappraisal of equity exposure from investors. Apart from anything else, a capitalist economy depends upon equity capital being able to earn more than the fixed coupon returns of bonds. As an investor, you at least need your savings to keep pace with inflation.
The UK picture tells a similar story. Bond funds have outsold equities in 12 of the last 13 months, achieving net sales of £6.7 billion versus equities which have recorded net outflows during this period (source: IMA). Indeed, this flood of bond sales prompted the FSA to look into risk controls in actively-managed corporate bond funds given possible redemptions and low market liquidity in the sector.
Perhaps it’s not as strange as the proverbial curate’s egg. Choosing which single asset to invest in has become increasingly difficult and investors don’t trust equity funds to deliver the kind of returns seen in the past. While demand for equity funds has fallen, there is an increased awareness of the need for asset diversification. This is reflected in strong demand for mixed or multi-asset funds (now the third largest IMA category) as investors seek to diversify their portfolios with reduced volatility versus traditional products. Balanced risk products that seek to manage returns for a certain level of risk are increasingly favoured. Risk-rated funds offering a diversified multi-asset approach are also expected to benefit from the post-RDR investment environment.
¹ source: Thomson Reuters Datastream, as at 31/10/12
² source: Barclays Capital, as at 31/10/12
Bambos Hambi, Head of Fund of Funds Management, Standard Life Investments
First Published in Investment Adviser on 19th November 2012