Unprecedented numbers of retail investors have fled the stock market in the past year and have sought stability in fixed income funds. Bloomberg Businessweek puts the flows in context:
According to TrimTabs Investment Research, investors poured $467.2 billion into bond mutual funds in 2009 and a further $115.8 billion so far this year. By contrast, an average of $43 billion flowed annually into bond funds from 2003 to 2008.
According to TrimTabs, $11.9 billion has been pulled from U.S. equity funds in the last 12 months, even as the S&P 500, the broad stock market index, rose 76 percent since Mar. 9, 2009.
Obviously, the meager returns for US equity index investors over the last decade, coupled with wild volatility, has resulted in many retail investors swearing off stocks and seeking stability. However, I wonder how many of these investors who have fled to fixed-income have given adequate consideration to the interest rate risk involved in their investment. Bond fund investors are playing a very different game than individual bond investors. Individual bond investors can hold the bond until maturity and can therefore avoid losing principal. That is not the case for bond fund investors. They absolutely can lose principal if interest rates rise from their current depressed levels, and, ironically, end up in the very predicament that they were seeking to avoid.
Clearly, this migration among retail mutual fund investors from equity funds to bond funds speaks to the emotional beating that investors have taken in the past decade. They need a different solution than what they had before. Yet, the solution of forsaking one asset class for another based on emotion is highly unlikely to be a good long-term solution.
A much more enlightened alternative is to adopt a global tactical asset allocation approach that broadens the investment universe to stocks, bonds, currencies, commodities, real estate, fixed income, and even inverse equities. In a global tactical asset allocation strategy, driven by relative strength, asset allocation changes adapt to new leadership. Changes to the portfolio are made in a systematic fashion based on data rather than emotion. Perhaps the biggest advantage of this type of approach is the flexibility to seek to capitalize on current opportunities rather than seeking to constantly fight the last battle.
