Bond Funds Still Winning Favor

Strategic Insight recently posted their summary of mutual fund flows for December...

Bond funds saw flows moderating to $29 billion in December, but still ended up establishing an all-time record for the full year with an almost $400 billion net intake. In contrast, flows into equity funds remained subdued despite the ongoing global stock market revival due to investor ambivalence about its sustainability, and continuing low risk appetites overall. Within the equity fund area, the recent dichotomy between internationally-investing and US-focused programs persisted, with the former continuing to draw modest inflows (helped by investor interest in boosting emerging market allocations in their portfolios), and the latter suffering small net outflows. December saw international equity funds garnering $8 billion.

Why bond mutual funds?

I have reported that bond mutual funds have been getting the majority of new dollars from fund investors, according to Strategic Insights. So what are the expectations from a portfolio of corporate bonds. Here are a couple of charts from the St Louis Federal Reserve illustrating current yields on two types of bonds, high quality (Moody's AAA) and medium quality (Moody's BAA).

Click on graph for a larger image

As you know, bond yields and prices move in opposite directions to each other. So as yields have come down, prices have moved up. And many would say that the opportunity for big double digit returns from bond funds, as we have recently enjoyed, is a once in a lifetime opportunity. These graphs seem to illustrate that too. As you can see, yields have dropped to near recent historic low levels, not leaving much hope for still lower yields and higher prices. In this environment, mutual funds that use a buy and hold strategy can expect no more than the coupon (dividends). On the other hand, funds that employ trading strategies to take advantage of apparent mispricing could add to the total return of the fund. Scanner