November 9, 2012 7:56 pm

Bond fund inflows crosses $400bn mark

Investor inflows into bond funds have crossed the $400bn mark this year, underscoring the ravenous appetite for fixed income among pension funds and insurers.

Bond funds tracked by EPFR Global, a data provider, attracted almost $10bn in the week ending November 7, extending what is a record-breaking year for the asset class. High yield, US and mortgage-backed bond fund inflows have all hit records, and emerging market bond funds are on track to do so.

“With seven weeks of the year remaining bond funds are collectively well into record setting territory when it comes to attracting fresh money,” the data provider noted in its report.

Some asset managers and strategists warn that there could be a bubble brewing in bond markets, as yields are pushed continually lower by the hunger for fixed income.

“We’ve had a decade where bonds have performed massively. It now smells like a crash may come,” said the chief executive of one London-based asset manager. “Fixed income is so expensive.”

Nonetheless, most asset managers expect the good run for bonds to continue, arguing that large parts of the developed world face an extended period of low growth, low inflation and cautious companies – all factors that favour fixed income.

Corporate bonds have proven particularly popular since the financial crisis, as investors shy away from the government debt of western countries, where returns are considered either too low or the risks too high.

Companies have responded by increasing their bond sales, taking advantage of rock-bottom interest rates to replace their bank debt with bonds.

Emerging markets have also been a beneficiary of the so-called ‘hunt for yield’, with governments and companies in the developing world enjoying the lowest borrowing costs on record. Issuance has also soared as European banks have retrenched from emerging markets.

The rally in bond markets has generated returns of up to 20 per cent in 2012, according to Stephen Major, head of global fixed income research at HSBC.

Central banks have helped buoy the bond market via quantitative easing programmes – in effect creating money to buy government bonds, increasing the amount of money in the financials system.

Rather than find its way into the real economy, the central bank-created liquidity has for the most part filtered into financial markets and bond markets in particular.

“Deployment of central bank balance sheets has been a key factor driving valuations, not just in the developed markets where QE has been used but globally,” Mr Major said in a recent note.

Yet there are several risks, not least the fact that central banks will at some point unwind their easy monetary policies, and let their benchmark rates rise again. “We only need a slight reversal to more normal interest rates and a lot of people will lose a bucket of money,” said one senior portfolio manager.

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