Bond Investors Seeking Higher Yields

Although investors have continued to overwhelmingly favor bond funds over equity funds—taxable bond funds have netted $200 billion in inflows so far this year compared with a scant $4.3 billion to equity funds—their risk tolerance has remarkably changed.

Because yields on mainstream bond funds are so low, investors’ appetite for lower-quality, higher-risk bond funds, including those invested in mortgage-backed securities, has once again returned.

The renewed appetite for higher-yielding products could be at investors’ peril. As Jon Short, a PIMCO managing director and head of U.S. institutional business development, told The Wall Street Journal, it still “might be a better time to worry about return of your capital than return on your capital.”

While money market funds are currently yielding practically nothing, as soon as there are indications that the Federal Reserve could announce an increase in the Fed funds rate, short-term rates, particularly in money market funds, will move up, said Eric Jacobson, director of fixed income research at Morningstar. Likewise, Stephen Walsh, chief investment officer for Western Asset Management, believes short-term bond and municipal bond funds are a good choice.