Recent market returns and events have led to record inflows into fixed-income mutual funds, which received $246 billion in net inflows in the year 2010, according to the Investment Company Institute, versus outflows of $29 billion for equity mutual funds. Certain mutual fund families, such as Pimco, and in particular the Pimco Total Return Fund, received a seemingly disproportionate amount of these flows. While past research has explored the impact of fund flows on equity mutual funds, little research has been devoted to exploring the impact of fund flows on the subsequent performance of actively managed fixed-income mutual funds.
This paper explores the impact of new monies, defined as net mutual fund flows, on the future performance of actively managed mutual funds classified as Intermediate-Term Bond by Morningstar from 1996 to 2009. The cost of putting new monies to work, though—or the “cost” of fund flows—was estimated to be approximately 40 bps in this analysis. Additionally, this research notes that more expensive bond managers do not appear to be “worth” their fees (i.e., there is no relationship even on a gross return basis with regard to the relative performance of bond managers), while the mutual fund expense ratio was a key driver of relative performance. Taken together, this research suggests a bond investor is best served by buying a low-cost investment option, such as a passive portfolio, or a fund that is expected to receive few relative inflows versus its peers.
Bond Fund Assets
The last few years have been good for bond funds from a net flow perspective. As of February 2010, 21 percent of all mutual fund assets were invested in bond funds, according to the ICI. Bond mutual funds received $246 billion in net inflows in the year 2010, versus outflows of $29 billion for equity mutual funds. Figures 1 and 2 have been included to give the reader an indication as to the growth of bond fund assets through time and the relative significance of the recent monies flowing to bond funds, which have been significant both from a total dollar perspective and a percentage of assets perspective.
According to the ICI 2010 Fact Book, since 2004, inflows to bond funds have been stronger than what would have been expected based on the historical relationship between bond returns and demand for bond funds. A few secular and demographic factors may have contributed to this development: the aging of the U.S. population, growing aversion to investment risk by investors of all ages, and the increasing use of “funds of funds.” First, the leading edge of the baby boomer generation has just started to retire, and because investors’ willingness to take investment risk tends to decline as they age, it is natural for them to allocate their investments increasingly toward fixed-income securities. Second, the aggregate decline in risk tolerance likely boosted flows into bond funds in 2009. Lastly, funds of funds remained a popular choice with investors, and a portion of the flows into these funds was directed to underlying bond funds.