The move out of bonds, a trickle so far, could intensify as investors hit the reset button on their portfolios.

July 25, 2013, 3:22 p.m. ET

Bonds Could Get Swept Away by the Flow

Move Out of Bonds Could Intensify as Investors Hit Reset Button on Their Portfolios

JUSTIN LAHART

Investors’ love affair with bonds is going through a rough patch. If they don’t make up soon, things could get really rocky. With the Federal Reserve signaling that it will begin reining in its Treasury and mortgage-bond purchases later this year, the fixed-income arena has become a less-than-happy place. Bank of America Merrill Lynch’s index of U.S. corporate and government bonds fallen 3.8% since the start of May. Investors have noticed, pulling a net $78 billion from bond mutual funds in the seven weeks ended July 17, according to Investment Company Institute estimates.There could be plenty more to come, suggests Deutsche Bank strategist Binky Chadha. From the start of 2008 through May, bond funds saw a massive $1.3 trillion in net new inflows as investors responded to an environment where bonds not only seemed like the safer alternative to stocks, but, thanks to the strong returns that bonds were generating, the better way to make money. Net inflows into stock mutual funds stalled during the same period.

Mr. Chadha calculates that if bond-fund inflows had hewed to the trend established in the 20 years ended in 2007, inflows would have been a much smaller $400 billion. That points to an environment where many individual investors’ stock and bond allocations are badly out of whack.

Nor is it just individual investors who might have some rethinking to do. BofA Merrill Lynch’s “sell-side” indicator, which tracks the average equity allocation Wall Street strategists are recommending, stands at just 49.8%. (The remainder typically goes into some mix of bonds and cash.) While up from a record low of 43.9% a year ago, that is still well below the historical norm of 60% to 65%.

Wall Street strategists don’t control vast pools of money, of course. But they do hold a mirror up to what their clients are doing. So one message from the indicator is that, relative to history, institutional investors have undersized equity weightings, and oversized bond ones.

For bulls like Mr. Chadha, this all suggests that as investors adjust their portfolios, money could come gushing into stocks. He points out that past periods of rising rates were characterized by bond-mutual-fund outflows and equity-fund inflows.

Things other than flows, of course, should matter more for stocks—like prices and companies’ ability to generate profits. For anybody investing for the long haul, the prospect of a great rotation (as it is being called) out of bonds and into equities shouldn’t count as an overriding reason to get excited about stocks.

Still, the odd period where bonds were seen as an asset class that was both safer than stocks and better able to generate returns may be giving way to one where they are seen as both more dangerous and less likely to make gains.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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