by Jake Moeller.
The ten-year anniversary of the start of the Global Financial Crisis (GFC) has passed with less fanfare than one might expect. That is understandable; to this very day we are feeling the repercussions of that tumultuous event. For those of us caught up in that storm the anniversary evokes mainly unpleasant memories.
Bond funds were hit hard in 2008…
As we deal with ongoing central bank distortion and “lower for longer” interest rates, direct results of the GFC, it’s worth reflecting on the impact it had—and continues to have—on bond funds in the U.K. and Europe.
To contextualise this, we can examine historical fund flows. According to Lipper data, pan-European bond funds had haemorrhaged €500 billion by the end of 2008. It wasn’t until the end of 2013 that those outflows were recouped.
But have rebounded strongly
Talk of a “bond bubble” has been floating around for the last few years as the credit cycle has been fuelled by low debt-funding rates and insatiable investor appetite for income. Indeed, bond funds have been pan-Europe’s top-selling asset class for three of the last five years. Year-to-date as of June 30, 2017, net inflows of €161 billion suggest that in the absence of any major market shock, we could see the best year for the asset class in the ten years since the GFC.
Exhibit 1. Pan-European Mutual Fund Flows by Asset Class 2004-1H 2017 (in Euro)
Should investors be concerned? The Lipper Global Bond GBP Corporate sector has returned a healthy 65% for the period from the start of 2007 to the end of 1H2017 (U.K. equities were up 83% and cash was up 25% by comparison). Recent returns are still buoyant (+2.6% for 1H2017), and there is little sense of impending doom by bond fund managers–although most recognise the easy-beta play has long sailed.
Bond managers have learnt crucial lessons from the GFC
Before the GFC the rules of risk premia for assets above cash were inviolate. That confidence ended after 2008 when even many investment-grade bonds couldn’t be marked to market. Since then, the industry has paid a lot more attention to the vagaries of the bond market and how they affect bond funds.
Bond fund managers have learnt a lot of lessons; a better understanding of credit ratings and the importance of covenants in high-yield and loans are examples. Similarly, managers have not succumbed to the siren call of increasing credit risk to boost yield– in the flexible IA UK Strategic Bond sector the average BBB-rated exposure in 2007 was only 13.2%; today it is 26.6%. Fund gatekeepers and selectors too are much more diligent about fixed income fund composition, and there is considerably more forensic analysis of bond funds than there was in 2006.
Due-diligence on bond funds improved but beware passive money
Such improved analysis and learnt lessons augur well. Bond funds may remain in calm waters for a while longer, but there is certainly a sea change coming for rates and central bank activity. Another cloud is passive money. Flows into pan-European bond ETFs are growing considerably; for 1H2017 they constituted 10% of all bond fund flows.
10 years on from the GFC, it is arguably a happy anniversary for a recovered and robust bond-fund market. However, in current conditions, I for one would prefer an active fund captain in charge of the bond ship.