Nervous investors have pumped over $30 billion into fixed-income exchange traded products so far this year. Bonds have been favored over stocks in the risk-off market.
Of course, historical flow patterns reveal that fund investors are horrible market timers. There are worries that investors who have piled into bond funds could be hurt by rising interest rates or inflation.
There has been a “mad rush” into fixed-income ETFs the past year, says Paul Justice, director of North American ETF research at Morningstar. [ETFs Gather Over $4 Billion in May as Bonds Favored]
In mutual funds, over the same period, more than $115 billion has left equity funds, while $172 billion went into fixed-income funds.
“To me, these figures are staggering,” Justice wrote in the latest edition of Morningstar’s ETF newsletter. “What we are witnessing is a full-blown retreat from risky assets and into perceived stability.”
Investors have been bombarded with warnings about the dangers of rising rates, but Treasury yields continue to fall to record lows. Yields on the 10-year note recently dropped below 1.5%.
Clearly, investors are worried about deflation. However, a rise in interest rates would punish investors in bond funds. Also, rising inflation would hurt due to decreased purchasing power.
“I fully support getting your risk-tolerance balance in check, but [the rush to bond funds]seems like an overcorrection to me,” Justice wrote. “With interest rates remaining near all-time lows, what good can possibly come from all this interest in fixed income? I understand that stocks may seem scary, but bonds can underperform, too.”
Ashmore Investment Management estimates that anyone holding a 10-year Treasury bond when yields return to their historical average stands to lose more than 30% of their money. The average yield on the 10-year note over the past five decades was 6%, or closer to 7% if the spike in the early 1980s to nearly 16% is included. [Are Treasury ETFs Risk-Free?]
iShares Barclays 20+ Year Treasury Bond Fund (NYSEArca: TLT)
Full disclosure: Tom Lydon’s clients own TLT.
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