Bond ETF Outflows Spike As Rates Rise

August 22, 2013

No one's sure what the Fed will do, but accelerating bond outflows amid rising rates suggest investors aren't waiting around to find out.

Investors have been pulling money out of the bond market at a near-record pace this month amid strengthening views that the Federal Reserve, as it suggested in May, is indeed likely to soon begin ending the extraordinary period of quantitative easing that began when the economy fell apart in 2008.

The latest strand to the tale was yesterday's Fed minutes from its late-July meeting hinting that the so-called tapering of the central bank's current $85 billion a month bond-purchasing program aimed at holding down borrowing rates could come as early as next month.

About $5.5 billion has flowed out of bond ETFs through Aug. 21, according to data compiled by IndexUniverse. That wipes out the $4.2 billion in fixed-income ETF inflows in July, though the month-to-date figure for August still remains, for now, shy of June bond-ETF outflows of more than $7 billion.

The outflows are a tangible result of the rise in interest rates since Fed Chairman Ben Bernanke first made his "tapering" comments on May 22. Benchmark 10-year Treasury yields, which were at about 1.6 percent on the eve of those comments, are now on the verge of crossing the 3 percent threshold.

Yields on existing bonds are rising to match higher coupons of newly issued debt—a dynamic that causes bond prices to drop. Those price drops become increasingly sharp the longer the maturity, or duration, of the debt.

Through Aug. 19, bond mutual funds and bond ETFs together had total outflows of $30.3 billion—already the third-highest total on record, with more than a third of the month to go, according to data compiled by TrimTabs Investment Research that goes back to 1984. Again, ETFs make up about a fifth of that total.

The accelerating outflows come on the heels of one of the most powerful bond market rallies in memory following the stock market meltdown in 2008-2009. Moreover, the current price and yield reversals in the bond market are seen by many as incipient signs that a historical reversion to the mean is manifesting in the bond market after a secular bull market in bonds took shape in the early 1980s.

"The record inflows into bond funds in the previous four years likely account for the intensity of the recent redemptions," TrimTabs Chief Executive Officer David Santschi said in a press release. "A staggering $1.20 trillion poured into bond mutual funds and exchange-traded funds from 2009 through 2012.

"Many investors probably didn't grasp the interest rate risk they were taking. Now that they're suffering losses in funds they regarded as 'safe,' they want out fast," Santschi said.

TrimTabs, which said combined bond mutual fund and bond ETF outflows totaled a record $69.1 billion in June and an additional $14.8 billion in July, noted that redemptions have been heaviest in funds investing in municipal bonds and Treasury bonds.

It's noteworthy that the inflows into bond ETFs in July weren't matched in the mutual fund space. The divergent flows stories suggest that the zero-sum game in equities—namely, inflows into ETFs and outflows from mutual funds—is now repeating in the world of bonds. Cheaper funds and that data suggesting active management can't beat indexing over the long haul are likely the explanations.

Looking at specific ETFs, in the No. 2 spot for top month-to-date redemptions was the iShares 3-7 Year Treasury Bond ETF (NYSEArca: IEI), which bled $2.33 billion, or nearly half of its assets, according to data compiled by IndexUniverse.

The outflows suggested that investors are aggressively shortening duration, purging debt holdings even on the shorter end of the Treasurys yield curve.

Investors also yanked $754 million out of the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) in the month-to-date period, leaving about $14.4 billion in the big junk bond fund.


August 2013 MTD ETF Flows By Assets ($,M)
Asset Class Net Flows AUM % of AUM
U.S. Equity -13,419.02 785,072.37 -1.71%
International Equity 4,693.87 347,765.40 1.35%
U.S. Fixed Income -5,275.56 223,538.42 -2.36%
International Fixed Income -282.51 25,278.06 -1.12%
Commodities -560.63 77,514.74 -0.72%
Currency -24.69 2,197.77 -1.12%
Leveraged 649.65 16,891.20 3.85%
Inverse 731.85 21,077.70 3.47%
Asset Allocation 1.68 3,594.58 0.05%
Alternatives 21.34 3,552.75 0.60%
Total: -13,464.02 1,506,482.99 -0.89%
August 2013 MTD Biggest Losers ($, M)
Ticker Name Issuer MTD Flows MTD Flows AUM MTD Flows Turnover
SPY SPDR S&P 500 SSgA -12,091.90 139,220.60 222,473.19
IEI iShares 3-7 Year Treasury Bond BlackRock -2,336.63 2,522.73 3,809.61
XLF Financial Select SPDR SSgA -1,303.28 15,012.39 9,718.69
QQQ PowerShares QQQ Invesco PowerShares -1,154.69 35,832.49 24,347.42
LQD iShares iBoxx $ Investment Grade Corporate Bond BlackRock -1,048.09 17,655.03 2,868.39
IWM iShares Russell 2000 BlackRock -774.83 24,413.52 39,867.65
EWZ iShares MSCI Brazil Capped BlackRock -770.30 4,593.33 11,274.97
HYG iShares iBoxx $ High Yield Corporate Bond BlackRock -754.40 14,397.26 5,134.61
UST ProShares Ultra 7-10 Year Treasury ProShares -726.59 17.51 1,161.08
XLY Consumer Discretionary Select SPDR SSgA -672.00 6,237.63 3,846.01

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