December 5, 2016

The Beginning of the Great Rotation Out of Bond Funds?

by Tom Roseen

Is this the beginning of the great rotation out of fixed income funds? Despite a plus-side return (+0.17%) for the fund-flows week ended Wednesday, November 30, 2016, investors continued to be net redeemers of taxable bond mutual funds and exchange-traded funds (ETFs), withdrawing a net $3.0 billion from the group. According to the CME Group’s FedWatch Tool, investors are pricing in a 92.7% probability that the Federal Reserve will hike its key lending rate 25 basis points in December. The ten-year Treasury yield ended the month of November at 2.37% (its highest closing value since July 20, 2015).

In the post-election equity rally investors continue to bet that President-elect Donald Trump’s economic plans to implement significant corporate tax cuts, deregulation, and infrastructure development will spur economic growth—which many believe will be inflationary and a drag on fixed income securities.

For the month of November investors redeemed a net $17.9 billion from taxable bond mutual funds and ETFs (looking only at weekly reporting funds; sums for monthly reporting funds will begin to roll in over the next few days). This most recent five-week stretch of net redemptions was the longest since the week ended January 20, 2016, a hangover from the 25-basis-point increase in the Fed Funds rate on December 17, 2015.

Weekly ENFs and Returns Taxable Bond Funds 20161130

Interestingly, there was a significant divide between mutual fund investors and authorized participants (ETF investors). For the month of November mutual fund investors redeemed a net $10.6 billion from taxable bond funds (with the lion’s share coming from corporate investment-grade debt funds [-$4.1 billion] and flexible funds [-$3.0 billion]). Meanwhile, their ETF counterparts were net purchasers of taxable bond ETFs, although to the tune of only $290 million, with corporate high-yield debt ETFs and corporate investment-grade debt ETFs attracting the majority of the assets, taking in $2.0 billion and $0.9 billion, respectively.

As might be expected, given inflation expectations and the probability of a rate hike in December, Thomson Reuters Lipper’s Inflation-Protected Bond Funds classification took in money for the seventh consecutive week (+$156 million for the most current fund-flows week, including both conventional funds and ETFs). Bank loan funds witnessed their third week of net inflows, attracting some $339 million for the week.

Investors appear to be gearing up for interest rate increases, but it still might be a little premature to call this the beginning of the great rotation out of bond funds. After all, we saw the same pattern about this time last year. The resolve of the Fed to normalize interest rates and the president-elect’s ability to implement his plans to power up the U.S. economy will be telling factors going forward.

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