April 1, 2013 / 5:06 PM / 5 years ago

Little margin for error in bond funds -Columbia Management

NEW YORK, April 1 (Reuters) - Investors continue to pour money into fixed-income funds as an alternative to the share market volatility created after 2008’s recession, but equity flows are getting more enticing due to bond valuations, returns and growth prospects, Columbia Management said on Monday.

While bond prices are high and yields are low, leaving little margin for error if conditions deteriorate, the stock market continues to rise, with the benchmark S&P 500 index closing at a record high on Thursday.

Funds that invest in U.S. stocks have gained $42.3 billion in new cash so far this year amid the market’s torrid run-up, but taxable bond mutual funds have garnered nearly as much, with inflows of $37.3 billion, according to data from Thomson Reuters’ Lipper service.

One way of maintaining the flow into fixed income is through risk management to avoid the “pot-holes” that might exist in the bond market. Such pot-holes could come from investors changing their expectations about Federal Reserve policy or from fiscal policy in the United States, “where we still have not seen the full impact of tax hikes and sequestration,” said Gene Tannuzzo, Senior Portfolio Manager, Strategic Income at Columbia Management.

And if U.S. rates begin to drift higher, causing price losses on interest-rate sensitive bonds, investors could get spooked and start to move money out.

In addition, if equity markets continue to rise, it could give some investors the confidence to invest more in the sector, perhaps funding purchases by selling bonds. If investors expect better times ahead for the economy, then it might be an attractive time to invest in equities, Tannuzzo said.

Fixed-income investors should be picky and focus on fundamentals in the current environment, according to Columbia Management.

“We like corporate debt exposure with a skew towards senior secured bank loans. We also like emerging market debt in countries with improving fundamental profiles,” Tannuzzo said.

He added that investors should be more cautious about bonds with long durations or excessive foreign currency risk.

According to Tannuzzo, a successful fixed-income strategy in this environment is one that is diversified, flexible and driven by bottoms-up research to avoid the pot-holes the market might present in the future.

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