Image Credit: Christophe Vorlet
By Jason Zweig | Sept. 22, 2017 11:02 am ET
Bonds have been in a bull market for most of the past 35 years or so. Many investors are still buying, but they aren’t chasing past performance.
In August, more than 90% of the $30 billion that flowed into all mutual funds and exchange-traded funds went into taxable-bond funds, according to research firm Morningstar.
Yet the bond market has squeezed out only a 3% return so far this year, while U.S. stocks are up more than 13%.
Look at the money pouring into such funds as the iShares 20+ Year Treasury Bond ETF, which holds government debt maturing between 2036 and 2047. Through Sept. 20, this fund has had the strongest monthly, quarterly and year-to-date influx of money in its 15-year history. Investors have added $4.4 billion this year and $2.7 billion in September alone; the fund has nearly doubled in size, to $9.9 billion, since the end of February.
Fund investors are notorious for buying whatever has recently had hot returns, often right before it goes cold. If you map the performance of bonds against the money going into and out of bond funds over the past couple of decades, you can see the public chronically — almost addictively — buying after bond prices have shot up and selling after a drop.
What’s happening now is the opposite. Investors seem to be moving from stocks, the hot asset, to bonds, the cold one.
Over the past year, long-term Treasury bonds have lost more than 4%, and the overall bond market has delivered a gain of less than 1%, counting interest payments.
What’s more, at this past week’s Federal Reserve’s policy meeting, officials left open the possibility of another interest-rate rise by year end and lowered their forecast of rates over the longer run from 3% to 2.75%.
So why are investors buying bond funds hand over fist?
The figures commonly cited to show how much money the public puts into or takes out of mutual funds don’t include any income from such funds that investors plow back into their accounts. Through July, according to the Investment Company Institute, those reinvested dividends totalled nearly $51 billion.
Instead of sporadically spending that income, investors are automatically putting it back in. Over time, that raises their stake in bonds, providing more ballast if the stock market becomes turbulent.
A “healthy mix of institutional and retail investors” have been buying the iShares long-term Treasury fund, says Karen Schenone, fixed-income strategist at the firm. “They seem to be saying, ‘I’ve done well in the stock market in the past few years, so maybe it’s time to take some of that risk off the table.’”
People are buying bond funds for their stability relative to stocks “rather than to take advantage of an expected rise in bond prices,” says Van Hoisington, lead manager for the $363 million Wasatch-Hoisington U.S. Treasury Fund. “Maybe the average, supposedly unsophisticated investor is right.”
Fran Kinniry, an investment strategist at Vanguard Group, points out that U.S. stocks have more than tripled since the financial crisis. So an investor who had 60% in stocks and 40% in bonds then would have more than 75% in stocks now.
Stocks have done so well that bond funds are only about 25% of investors’ total portfolios, down from 31% in 2012, according to the ICI.
Getting those ratios back into balance requires buying a lot more bonds.
“Back in the late 1990s, investors were very momentum-based, buying stocks and selling bonds,” says Mr. Kinniry. “But now, here we are in the midst of this giant bull market for stocks, and I love seeing that investors are buying bonds instead.”
Yes, many long-term bond funds will fall in price by 15% or more on a rise in interest rates of just one percentage point. For the most part, though, investors aren’t buying riskier vehicles like emerging-market bond funds or high-yield corporate funds. Instead, hordes of retirees and near-retirees are moving into more-conservative investment-grade and government funds with lower risk of default and moderate sensitivity to rising interest rates.
And with the S&P 500 brushing all-time highs and interest rates too low for bond funds to provide generous income, neither stocks nor bonds look particularly attractive.
During the financial crisis, however, high-quality bonds like U.S. Treasurys were one of the only assets that did well when stocks got trashed.
Government bonds “have continued to be the strongest flight-to quality asset,” says Mr. Kinniry, and remain likely to do well in future stock-market crashes unless interest rates unexpectedly rise at the same time. For many investors, bonds feel like the lesser of two evils.
Source: The Wall Street Journal, http://on.wsj.com/2xtAziv
For further reading:
Definitions of BOND, CENTRAL BANK, FIXED INCOME, PRINCIPAL, YIELD in The Devil’s Financial Dictionary