Bond funds selling faster than tech during bubble

The sales of bond funds in recent months has eclipsed the inflows seen into equity funds in the months leading up to the explosion of the technology bubble.

As advocates of the asset class seek to dismiss claims that it is a bubble, it will be daunting to see off the evidence provided by Morgan Stanley research. It found that in the 12 months leading up to September 2000 some $340 billion flowed into US equity funds. Over the twelve months up until April 2010 a full £410 billion flowed into bond funds.

The research echoed recent work by former Société Générale strategist James Montier, which suggested we may be one the verge of an inflection point in the fixed interest markets.

Morgan Stanley's leading European equity strategist Matthew Garman argues that we should take this as evidence of exactly what it looks like: A contrarian indicator for corporate bonds.

He said: 'At extremes mutual fund flows have been reasonable contrarian indicators. The peak of the TMT bubble coincided with extreme inflows into equity funds in both Europe and the US.

'In the first quarter of 2000, US equity funds saw inflows of almost 4% of assets which, in hindsight, clearly marked the zenith of the equity bubble. In addition, ahead of the market troughs in 2002/03 and 2009 we also saw significant mutual fund outflows from US equities.'

Garman is realistic that this is not a perfect indicator, pointing out that studying mutual fund flows would have not proved enough to spot the 2007 equity peak or the trough in 2000 that led to a strong bond rally.

Garman also looked at the relative size of bond markets compared to equity markets and noted that at the peak of the tech boom when equity markets were effectively 'too big' they were around the same size in total as bond markets. Now equity markets in the United States are just 40% of the size of the bond market.

What this does mean of course is that if money suddenly starts to flow from bonds into shares it is likely to have a bigger impact on shares than on bonds.

The lesson for Garman is much as it has been for a range of leading asset allocators recorded on Citywire in recent weeks such as William Littlewood from Artemis and Bob Parker from Credit Suisse; Own large-cap equity yield stocks over bonds.

He said: 'Continued macro uncertainty and muted risk appetite in a low rate environment have driven investors' attraction to yield. While money market funds have seen large outflows through the course of 2009-10, both government bonds and corporate credit have seen large inflows.

'Since the start of 2009 US money market funds have seen cumulative outflows of around 30% of assets, while there have been large inflows to both government bonds and corporate bonds.