ICI GMM 2012: Bond Fund Fans Could Get Burned

In the week ending May 2, investors yanked $6.60 billion from mutual funds that invest long-term in U.S. stocks. And put $7.51 billion into bond funds.

Since the start of 2007, $525 billion has been pulled out of domestic stocks funds, in fact, according to Investment Company Institute statistics.

And it’s been bond funds that have been investors’ preference, pulling in $1.0 trillion in that same time.

But investors could get burned on bonds, when the market turns, fund executives said Thursday morning at the ICI’s General Membership Meeting.

Investors already are piling into U.S. Treasury bonds that are generating negative returns, in effect, said Paul Haaga, chairman, Capital Research and Management Company. That’s because the interest being paid -- 1.87% on a 10-year Treasury note as of Wednesday -- already is below the nation’s inflation rate.

Even though the returns on bond funds have been good, a big part of that has been due to the appreciation in the price of bonds, noted Maria A. Chandoha, president and chief executive, Charles Schwab Investment Management.

That’s where the rub comes in. Interest rates are going to rise, from what right now are extremely low rates, historically. And when that happens, bond prices will fall. And so will the value of bond funds.

“I am not very sure that people are ready to see returns turn when rates rise,’’ Chandoha said.

In general, retail investors “are on their maximum allocation to bonds,’’ said Ken Olivier, chairman and chief executive, Dodge & Cox.

While bonds are looked at as an anchor in a financial storm, there is no question that bond prices will go down when interest rates go up. And that investors should diversify their holdings, ahead of that.

But investors often do not. “As soon as bond prices go down, there’s a shock to that,’’ said Olivier.

Chandoha said there could be some areas of fixed-income investing still worth looking at, such as high-yield bonds and shorter duration bonds.

Investors should take a wider view of what they should be looking for, said Ronald O’Hanley, President, Asset Management and Corporate Services, Fidelity Investments.

First stop: Looking at dividend-paying stocks.

“It’s not about all bonds or no bonds,” O’Hanley said. “It’s about where are there income-producing opportunities.’’

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Mutual funds Money Management Executive
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