Saturday, September 4, 2010

Moving into Bonds: From Frying Pan to Fire

By Kevin Brekke
With the great bond stampede that began in 2009 continuing, giving rise to the very real possibility of a bond bubble, we decided to check the relationship between bond returns and bond fund inflows to see if there might be a correlation. Take a look at this chart:

    (1) Measured as the year-over-year change in the Citigroup Broad Investment Grade Bond Index.


    (2) Plotted as the three-month moving average of net new cash flow as a percentage of previous month-end assets. The data exclude flows to high-yield bond funds.

As suspected, the rise and fall in total return from bond funds is accompanied by an influx or exodus of bond investors. Data to construct the chart were taken from the Investment Company Institute’s (ICI) 2010 Fact Book where they state,

In 2009, investors added a record $376 billion to their bond fund holdings, up substantially from the $28 billion pace of net investment in the previous year. Traditionally, cash flow into bond funds is highly correlated with the performance of bonds. The U.S. interest rate environment typically has played a prominent role in the demand for bond funds. Movements in short- and long-term interest rates can significantly impact the returns offered by these types of funds and, in turn, influence retail and institutional investor demand for bond funds.” (more)

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