Investors shun bonds and seek stock ETFs despite fiscal worry

NEW YORK Fri Dec 21, 2012 3:58pm EST

NEW YORK Dec 21 (Reuters) - Investors finally soured toward bond funds and favored riskier stock exchange-traded funds in the latest week despite gridlock over negotiations to avert the nearing "fiscal cliff" and a typically cautious year-end trading period.

EPFR Global, a fund-tracking firm, said on Friday that investors around the world pulled $3.87 billion from funds that hold U.S. bonds in the week ended Dec. 19, the most in roughly a year and a half. The outflows account for most of the total outflow of $4.1 billion from bond funds worldwide.

It has been another strong year of cash inflows into U.S. bond funds, which have raised concerns about a potential bond bubble. Money managers, particularly fixed-income investors, have warned that the solid rise in bond prices cannot go on forever. Junk bonds and corporate debt "which we felt good about a year ago ... we now feel OK about," said Tad Rivelle, chief investment officer of fixed income at TCW, which has $135 billion in assets under management.

For their part, stock funds globally attracted inflows of $5.56 billion, keeping up demand after the funds gained $8.88 billion in new money the previous week. Inflows into funds that hold U.S. stocks accounted for $1.16 billion of that total.

Emerging market stock funds accounted for much of the overall demand for stock funds worldwide with inflows of $4.44 billion.

The overall inflows into stock funds was mostly a result of investors piling into exchange-traded funds, EPFR Global said. ETFs, which are generally believed to represent the behavior of institutional investors, can be used opportunistically to bet on various indexes.

ETFs that track the benchmark S&P 500 stock index offer higher yields and dividend growth compared to the low interest rates on bond funds, said Jim Awad, managing director at Zephyr Management in New York.

NO ROOM FOR RISKY BONDS

Among bond funds, riskier high-yield "junk" bond funds had outflows of $281 million, the first outflows from the funds in four weeks after attracting more than $1 billion in inflows in each of the past three weeks.

Funds that specialize in European bonds, which are also considered risky given the region's debt crisis, had outflows of $1.03 billion, the most in over six months according to EPFR Global and a reversal of $1.07 billion in inflows the prior week.

Yields on European debt have come down as prices have rallied, leading many to believe that the risk is not worth the investment, Awad of Zephyr Management said.

The S&P 500 rose 0.51 percent over the reporting period despite gridlock between U.S. President Barack Obama and U.S. Republican House Speaker John Boehner in talks to avert the looming "fiscal cliff" of tax hikes and spending cuts that threatens to tip the U.S. into recession.

The yield on the benchmark 10-year Treasury fell to 1.75 percent in intraday trading Friday in the wake of House Speaker Boehner's failure to win support from his Republican party for a proposal that aimed to limit income-tax increases to those earning $1 million and more, a much smaller slice of taxpayers than Obama wants to pay higher taxes.

The data from EPFR Global, which tracks the sales behavior of investors globally toward funds stationed around the world, roughly coincided with data from Thomson Reuters' Lipper service, which reports weekly flows for funds based exclusively in the U.S. over the same reporting period.

With regard to these U.S.-based funds, investors pulled $1.6 billion out of bond funds, which was modestly lower than the highest outflows this year of $1.65 billion in May.

Investors are "harvesting accumulated gains of the past several years" from bond funds as interest rates grind lower and expectations for higher tax rates kick in, said Alan Gayle, senior investment strategist at RidgeWorth Investments.

A pullback from bond ETFs accounted for the total outflow from bond funds as investors yanked $1.61 billion from the index funds, which was the most this year.

Bond mutual funds did little to offset the pullback from bond ETFs and attracted meager inflows of just $8.57 million, the weakest showing for the funds in seven weeks.

Investors were averse to bonds across the risk spectrum and took $34.1 million out of funds that hold investment-grade corporate bonds, which is the first time the funds have suffered outflows since June.

Investors also took $344.74 million out of high-yield bond funds, the investment-grade funds' riskier counterpart, which is the first outflow for the group in four weeks.

INVESTORS SOUR ON STOCK MUTUAL FUNDS

U.S.-based stock mutual funds, meanwhile, suffered the biggest outflows this year of $6.43 billion over the period. The pullback is the most dramatic since August of last year.

Stock ETFs stationed in the U.S., however, showed similar results to those from EPFR Global on stock ETFs worldwide, with the funds gaining inflows of $5.85 billion.

Overall, U.S.-based stock funds- including both mutual funds and exchange-traded funds- had net outflows of $582.6 million, the first time the funds have returned money to investors in four weeks and showing a sudden drop in demand after net inflows of nearly $5 billion the previous week.

A couple walks along the rough surf during sunset at Oahu's North Shore, December 26, 2013. REUTERS/Kevin Lamarque

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