Tuesday, December 13, 2011

Retail investors' love affair with corporate bonds

That's right, a product that was a few years ago reserved for retirees and institutional investors - insurance, pensions (more retirees), etc. is now the darling of retail investors. Institutions and foreigners still hold the bulk of US corporate bonds, but the retail share via mutual funds and ETFs is growing each year (see below in blue).

Source:  Credit Suisse

In fact until recently corporate bond mutual fund assets have been growing rapidly - a trend started in 2009.

Source: Investment Company Institute, Bloomberg
The same trend can be observed in ETFs. A popular corporate bond ETF is the iShares iBoxx Investment Grade Corporate Bond Fund or LQD.  The chart below shows the growth in LQD shares outstanding.

LQD Shares Outstanding (Bloomberg)
So why all this interest in corporate bonds? One key reason is that retail investors continue to shy away from equities.
Brad Barber: My sense is that sentiment for equities isn't going to get positive until the economy is on strong footing. Even though the market has come back, it hasn't really been accompanied by robust economic growth. That can to some degree explain why retail investors remain skittish. The back story of the returns has just not been strong for the last year or two.
So far retail investors have been correct.  Corporate bonds have outperformed equities significantly.  As the chart below demonstrates, on a total return basis (including dividends and interest) LQD has outperformed the S&P500 by some 8% this year.  This outperformance has been caused by falling rates in the US and stagnating equity markets driven by "macro" concerns.  And as long as there is not a full resolution in Europe, this trend may continue.

Total return LQD vs. S&P500 (Bloomberg) 

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