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Our Fixed Income Fascination Continues


A whopping $203 billion has now been invested in bond funds, year to date. In comparison, domestic equity funds have raked in just $16 billion so far in 2010.

July might have proven a good month for the stock market, but the general investing public continued to sidestep equities.

The S&P 500 (SPY) and the MSCI EAFE (EFA) produced total returns of 7.0% and 9.5%, respectively, last month, but the rebound couldn't convince investors to put money to work in the stock market. Domestic equity funds suffered $8 billion in net outflows during July, according to data recently reported by New York-based Strategic Insight.

Fund shareholders remain worried about the uncertain state of the economy and the pace of employment growth, says Loren Fox, Strategic Insight's senior research analyst.

"It has been a rough few months," Fox says. "A lot of investors have become more anxious again about the economy. It's not exactly encouraging when Ben Bernanke calls the economic situation unusually uncertain."

Investors, while showing little love for the home team, did eyeball some opportunity overseas: US-based international equity funds saw net inflows of $5 billion.

Broadly, though, investors remain fixated on the fixed-income market: They shoveled $31 billion into bond funds in July. Leading the inflows were short- and intermediate-maturity corporate bond funds as well as emerging market bond funds, which attracted $1.5 billion, says Fox.

In total, a whopping $203 billion has now been invested in bond funds, year to date. In comparison, domestic equity funds have raked in just $16 billion so far in 2010.

This enthusiasm for bonds mirrors the same trends that unfolded last year. Full-year 2009 inflows to bond funds -- including traditional mutual funds and ETFs -- reached an all-time record of $396 billion.

Vinny Catalano, president and global investment strategist with Blue Marble Research, says he expects investors to keep committing capital to fixed-income securities in the near term. For one, low interest rates will continue to encourage you and your neighbors to search for higher yields.

"The main driver for the move to bonds is this reach for yield," says Catalano. "Individuals want a return and while these returns might be low, they're better than the money market return. I also think we'll see them increasingly step down the quality spectrum."

Indeed, junk bond sales reportedly hit a record last week. Non-investment grade companies sold $14.3 billion of bonds in 26 deals. This year, 353 junk-bond deals have raised more than $175 billion for companies. That's almost double the same period in 2009, according to Thomson Reuters.

Investors can play the junk bond market with ETFs like the iShares iBoxx $ High Yield Corporate Bd (HYG) and SPDR Barclays Capital High Yield Bond (JNK).

Second, says Catalano, investors are trying to find relative safety against a very uncertain economic backdrop. A new study by the Federal Reserve Bank of San Francisco puts the odds of a new recession at just over 50% over the next two years as job growth remains anemic. (HT: Markman Capital Insight)

Still other strategists emphasize that what we might now be witnessing is a secular shift among investors in terms of where they're comfortable committing capital. After suffering through two bear markets, and a stock market that's gone nowhere in 12 years, many individual investors might have concluded that stocks aren't necessarily worth another sleepless night.

"There is something to that," says Dirk Van Dijk, chief equity strategist at Zacks Investment Research, adding, "A lot of people have been burned."

Separately, Strategic Insight estimated that investors put $7.5 billion into US ETFs in July. US ETF assets ended July at $831 billion. International equity and taxable bond ETFs accounted for the bulk of July's net inflows.

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