Global Fixed Income

Weekly discussion of fixed income market action and what it may mean for investors.

January 10, 2017

Brian Rehling, CFA, Co-Head of Global Fixed Income Strategy

Fund Flows Tell a Story

  • Flows into, and out of, mutual funds and exchange-traded funds offer insight into investor behavior. They also can significantly influence short-term performance.
  • Fixed income fund-flow data shows some significant differences in pre- and post-election trends.

What it may mean for investors

  • Yet, these recent trends may be moderating, and we believe that some of them bear watching for a reversal.
  • We also advise investors to ensure that their assets are properly allocated for the year ahead.

In efficient markets, supply and demand must balance, and this balance determines price. Investor reactions to new information often drive buying and selling decisions (supply and demand changes) and can influence short-term performance. One way to assess how investors are reacting to fixed-income market developments is to review mutual fund and exchange-traded fund (ETF) flows. Digging into the available data allows us to look at investor behavior and how that behavior may be changing.

Flow Data

Fixed-income investments have enjoyed net fund inflows for years. Investment Company Institute (ICI) data shows that there was more than $300 billion of net new flows into fixed-income mutual funds and ETFs from 2014 through late 2016 (December 28, 2016). Undoubtedly, these inflows helped support and drive strong fixed-income performance over that time period.

It is worth noting that investors were purchasing fixed-income investments during those years as fundamentals were clearly supporting the asset class. The bond market continued to enjoy strong new net inflows through much of 2016; even as yields began to drift higher during the summer of 2016. Following the U.S. election, these trends saw a sudden reversal—with net outflows, particularly in municipal securities, as retail investors shifted assets out of fixed-income investments. We expect to see individual investors begin to move money back into the municipal space over time as runaway rate fears abate and higher yields attract assets to municipal funds. We will watch ICI data to see if this reversal does develop. Until it does, municipal securities likely will continue to see some price pressures.

Unfortunately, it takes time to compile fund-flow data, and the most recent ICI data is for the week ending December 28, 2016. While this data is useful for macro trend analysis, it is more difficult to take a deeper fund-level look into fixed-income sectors on a real-time basis. Fortunately, ETF data is easily compiled in real time. Given the broad breadth and institutional acceptance of ETFs, we can garner meaningful insight by reviewing net ETF flows.

Analyzing flows into and out of 425 fixed-income ETFs provides a more detailed look at changing investor sentiment regarding fixed-income investments. Last year, all fixed-income segments saw ETF inflows prior to Election Day on November 8, 2016 (Chart 1).1

Chart 1. Fixed Income ETF Flows: Pre-Election (1/1/2016 – 11/7/2016)Chart 1. Fixed Income ETF Flows: Pre-Election (1/1/2016 – 11/7/2016)Source: Bloomberg, 1/9/17. Inflation-Protected Securities include Treasury Inflation-Protected Securities (or TIPS). Please see disclosures for a definition of these securities.. Past performance is not a guide to future results.

Yet, Chart 2 shows that, since Election Day, a number of trends are evident:

  • Investors have sold longer-maturity investments in favor of ultra-short and short-term ETF investments.
  • High-yield fixed income has been the beneficiary of tremendous inflows relative to investment-grade positions.
  • We have seen investors selling government bond, emerging-market debt and preferred stock fixed-income ETFs since Election Day.

These are reversals from what was seen earlier last year. We believe that many of these post-election trends are likely to be temporary, rather than persist over the longer term.

Chart 2. ETF Fund Flows: Post-Election (11/8/2016 – 1/6/2017)Chart 2. ETF Fund Flows: Post-Election (11/8/2016 – 1/6/2017)Source: Bloomberg, 1/9/17. Inflation-Protected Securities, or TIPS, are Treasury Inflation-Protected Securities. Please see disclosures for a definition of these securities.

Some of These Trends Have Begun to Moderate Since Year-end, But the General Themes Remain.

On January 3, 2017, we moved long-term fixed income tactical positioning to evenweight (neutral) from underweight.2 Data since the beginning of this year suggests that long-term fixed income selling has slowed but has not yet reversed (Chart 3). We believe that the reduction in selling pressure should help longer-term fixed income stabilize in the near term, supporting our evenweight positioning. As we stated in the detailed rationale of this change “While long-term fixed income valuations may be at fair value, it is possible that the recent market sell-off may continue a bit longer.”3 ETF flow data bears this out.

Chart 3. Fixed Income ETF Fund Flows: Early 2017 (1/1/2017 – 1/7/2017)Chart 3. Fixed Income ETF Fund Flows: Early 2017 (1/1/2017 – 1/7/2017)Source: Bloomberg, 1/9/17. Inflation-Protected Securities, or TIPS, are Treasury Inflation-Protected Securities. Please see disclosures for a definition of these securities.

On January 3, we also moved high yield fixed income to a tactical underweight from evenweight. This change was based on valuations that have clearly become expensive, coupled with challenging fundamentals. We expect that investors will continue to gravitate toward high yield in the near term, given its strong recent performance. However, we are beginning to see this trend moderate. Data for the most recent week shows that, while high yield ETFs attracted more new fund flows than investment-grade ETFs, the gap has shrunk significantly relative to what was experienced in the immediate post-election period.

Strong post-election outflows in fixed income gave some investors pause and reason to question their fixed-income allocations. In our opinion, those trends are unlikely to persist. Recent fund flow data suggests that selling pressures are moderating. With outflows moderating and fears abating, we encourage investors to review their fixed-income portfolio with their investment professional. We also advise investors to avoid overreaction and to assure that their assets are properly allocated for the year ahead.

1 Bloomberg, January 10, 2017.
2 Tactical Strategy Update: “Adjusting Our Equity, Fixed Income, and Real Assets Positioning,” January 3, 2017.
3 Tactical Strategy Update: “Adjusting Our Equity, Fixed Income, and Real Assets Positioning,” January 3, 2017.

Risk Factors

Investments in fixed-income securities are subject to interest rate and credit risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and principal. High yield fixed income securities are considered speculative, involve greater risk of default, and tend to be more volatile than investment grade fixed income securities. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity. In addition to the risks associated with investing in international and emerging markets, sovereign debt involves the risk that the issuing entity may not be able or willing to repay principal and/or interest when due in accordance with the terms of the debt agreement.

Definitions

Inflation-Protection Securities: Treasury Inflation-Protected Securities, or TIPS, are inflation-protected securities issued by the U.S. Treasury.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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