Dow Jones, February 4, 2010
The surge of Americans born after World War II, the Baby Boom, is triggering another boom--in bonds.
Large flows of cash into bond funds over the past year were partly driven by aging boomers as they shifted out of stocks and other investments into less-risky options such as bonds, some observers said.
And with an estimated 80 million boomers heading into retirement over the next decade, the pace of money going into bonds will support the fixed-income markets, they said.
"Even in an environment where interest rates are rising and bond returns are hovering around zero, we can continue to see inflows into bond funds because of these demographic trends," said Brian Reid, chief economist at the Investment Company Institute, or I.C.I., the association of U.S. investment companies that tracks fund data.
The effect of retiring baby boomers, commonly defined as those born in 1946 through 1964, remains a matter of debate, including any impact on bonds and on the economy overall. But Reid and others said recent trends in bond funds and retirement plans indicate boomers are indeed having an influence.
In 2006 and 2007, for instance, returns on bonds were negative, according to I.C.I. data. Yet money continued to flow into them--coincident with the older boomers starting to shift into more-conservative assets, regardless of returns.
Indeed, over the past 10 years, baby boomers have boosted their holdings of fixed-income assets and cut stocks. At the end of 2000, about 2.2% of boomers' assets were in bond funds, according to a Fidelity Investments survey of 401(k) plans. That percentage has jumped to 9.2% as of September 2009, said Michael Doshier, vice president in Fidelity's workplace investing group.
Inflows into bond funds accelerated over the past year, and for reasons unrelated to boomers: many investors flooded into bond funds because money market funds offered no returns and U.S. stocks were volatile.
But the flow of money into bonds was too large to be explained wholly by rocky stock and real-estate markets--especially considering that bond returns were not as extraordinary as the inflows, Reid said.
For instance, the three-month moving average of new cash flow into bonds, as a percentage of total assets, was 1.7% in December 2009, near historic highs. Meanwhile, the Citigroup Broad Investment Grade Bond index return year-over-year was 5%--a good showing, but not as extraordinary relative to the past.
In addition, there has been growth of so-called target-date funds, which shift people's investments based on retirement targets. And automatic enrollment of employees into retirement plans, which legislation in 2006 helped to make easier, supports funds overall.
"Structurally, we're entering into a period where there will be a larger allocation into fixed-income," said Richard Tang, head of fixed-income, foreign exchange and equity sales in the Americas for RBS Securities in Stamford, Conn. "We're already starting to see that happen."
John Lonski, a Moody's economist, said that recent volatility in stock and home prices may make some boomers even more risk averse--and thus candidates to buy bonds. "Given the loss of wealth to lower share prices and lower real estate prices, these boomers will be more conservative in their portfolios," he said.
The shift toward bonds doesn't necessarily mean stocks will suffer, since many factors, such as corporate earnings, also influence equity performance.
Still, some remain skeptical. John Ameriks, head of Vanguard's Investment Counseling and Research Group, attributed recent bond inflows to disappointment with stock market returns, not a demographic shift.
But some are already girding for the sea change they predict in bonds. For one, supply of cash for corporate bonds would make it attractive for companies to sell debt. "Corporate credit is going to do well even as the economy suffers," said Tang at RBS.
Indeed, the need to put cash in safe investments may cause corporate bond risk premiums, or spreads, to fall to artificially low levels, said Moody's Lonski.
"Investors seeking safety may mistakenly narrow spreads to such a degree that it encourages potentially disruptive risk-taking by corporate borrowers," he said. "That could be a problem in five to 10 years."
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