Fixed Income Funds Return to Favour

VIDEO: Morningstar analyst Bhavik Parekh looks at where investors put their money in May and there are signs investors are turning cautious again after a bullish April

Holly Black 22 June, 2020 | 10:49AM

 

 

Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Bhavik Parekh. He is an analyst at Morningstar.

Hello.

Bhavik Parekh: Hello, Holly.

Black: So, we're here for our monthly catch-up about where U.K. investors have been putting their money. And after going for all the risky stuff again in April, it looks like people have turned cautious again in May. What's going on?

Parekh: Yeah. So, probably one of the key takeaways in May is that investors have been far less bullish than they were in April. So, in April, equity funds were very popular. We saw quite high levels of inflows into equity funds. But fixed income funds were relatively flat in flow terms. But in May, we saw a change, a reverse in that where equity funds were flat and fixed income funds were the most popular area of the market. And there's probably main two reasons for that. One, investors looked to be a bit more cautious.

Perhaps they are worried about a second wave of coronavirus and high net inflows into money market funds imply that could be the case. And in terms of fixed income specifically, around the world central banks have been buying bonds at very high levels and that will have provided a good level of liquidity to fixed income markets and that may have abated investor concerns over fixed income markets and they've gone back into fixed income where they had withdrawn very heavily from in March.

Black: Okay. So, if we do look at the equity funds that investors are choosing, there does seem to be this focus on growth type funds rather than value. Why is that trend emerging do you think?

Parekh: Well, I definitely wouldn't say that it's a new trend. Investors have been choosing growth over value for a number of months if not years now but the trend was definitely more obvious in May. And when we look at how the markets have performed this year, it's unsurprising, probably quite unsurprising. So, if we take U.S. large-cap, for example, the U.S. large-cap growth category, the average fund in that category has actually outperformed its equivalent value peer by almost 20% year-to-date. So, clearly, that's a very big difference and maybe investors have entirely given up on value.

I know a number of people have been saying that value is dead and perhaps investors have changed their minds where maybe they had some confidence in value and they don't anymore. And not only that, we've seen even movements from blend categories into growth categories. So, it's not just deep value anymore that's suffering. It's even the more core investments. And from manager meetings that we've had in the research team, there are even some managers that have said, yes, in the medium term growth will continue to outperform. So, it's not just your average investor who holds that view that growth will be the right way forward at the moment.

Black: Okay. So, we know as well that right now it's a really difficult time to find income because companies are cutting dividends and central banks have reduced interest rates. But it looks like equity income funds are still relatively popular. Why are investors looking to these funds do you think?

Parekh: Yeah. So, I was actually quite surprised to see U.K. equity income funds seeing inflows over the past two months. Since the Brexit referendum the category has been very bad. It's seen very high levels of net outflows month-on-month and it's really suffered. But in May and April, we actually saw some inflows into this category. And when you think about the reasons why, it's not entirely unsurprising.

So, for the average investor, there's a few areas where they can maybe get some income. One is their bank account. But as we all know, our savings accounts aren't really offering as much income at the moment. Two, in a fixed income fund. But when you think about the less risky areas of the market, those are not really yielding very highly. So, you're not going to get much income from those. And the riskier areas, the high-yield areas, yes, you're going to get some income from those, but perhaps investors still think they are a bit too risky at the moment. So, your third option maybe an equity income fund. And we have plenty of those in the U.K. and investors have chosen those.

Even though dividends have been under threat at the moment, at the end of May, the dividend yield for the FTSE All-Share was almost 5%. So, even if dividends are cut and that yield comes down, it's still a fairly decent yield and there's also a potential for capital appreciation given where the markets are at the moment in the U.K. So, it does make some sense that those funds have been popular over the past couple of months.

Black: I guess also investors who don't really know how to find income for themselves outsourcing it to an expert does make sense. Bhavik, thank you so much for your time.

For Morningstar, I'm Holly Black.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Holly Black  is Senior Editor, Morningstar.co.uk

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