Determinants of Flows into Retail Bond Funds

Abstract

Despite the growth of investments by individuals in bond funds, no research has investigated the determinants of these money flows into the funds. This study examined such determinants and the behavior of bond fund investors in the 1992–2001 period. Bond fund investors chase risk-adjusted performance leaders instead of raw return leaders. Bond fund investors, particularly investors in municipal bond funds and government security funds, are sensitive to expenses, such as operating expenses and sales loads. Poor long-term equity market returns tend to increase investors' investments in government security funds, Ginnie Mae funds, and high-quality bond funds.

This study addressed the determinants of net flows into retail bond funds as a whole and by investment objective. The study used a new dataset of all retail bond funds and covered the period 1992 to 2001.

Bond funds have become an increasingly important investment vehicle for individual investors, but despite the growth of investments into bond funds, no research has been done on the determinants of flows into the funds or the behavior of bond fund investors. A large literature has been devoted to the determinants of flows into equity funds, but these findings may not apply to bond funds because of differences in the characteristics of holdings and the profiles of investors. As a result, the behavior of bond fund investors needs to be studied in a separate investigation, which is the primary contribution of this article.

In addition to studying the determinants of flows into bond funds as a whole, this research studied the determinants of flows for the funds disaggregated according to their investment objectives: municipal bond, government security, Ginnie Mae (Government National Mortgage Association, GNMA), high-quality bond, high-yield bond, and global bond. The fixed-income instruments in the groups have different risk and return characteristics and may appeal to different investors. As a result, investors may exhibit different behavior toward the different types of funds.

The study found the following:

• Bond fund investors chase the funds that are the performance leaders on a risk-adjusted basis rather than on the basis of raw returns.

• Most bond fund investors—in particular, municipal bond fund and government security fund investors—are sensitive to expenses; they avoid funds with high operating expenses and funds that charge sales loads.

• Poor long-term equity market returns tend to increase investors' investments in government security funds, Ginnie Mae funds, and high-quality bond funds.

• Except among the high-quality bond funds, small bond funds receive higher net dollar flows than large funds.

• Bond funds from fund families with larger assets tend to receive higher flows.

• Investors in high-yield bond funds do not chase absolute performance and are more likely to rely on the assistance of brokers and financial advisors.

As the first comprehensive study of the determinants of flows into bond funds, this article sheds light on the behavior of bond fund investors with various investment objectives. These results enhance bond fund portfolio managers' and financial advisors' understanding of what drives the decisions of bond fund investors. These findings can also help senior executives and boards of directors of mutual fund families formulate their policies regarding fees and distribution channels.

I would like to thank Julie Agnew, Audra Boone, John Boschen, Diane Del Guercio, Bing Liang, Erik Lie, George Oldfield, Chris Taber, and Wanda Wallace.