There has been a fair amount of discussion and debate in the recent past about the possibility of a great rotation from bonds to stocks as a catalyst that drove equity prices higher. And now that we are trending or breaking all time highs in stocks, things are a bit clearer (read 3 ETFs Beating the S&P 500).
Given the recent developments in the domestic U.S. economy, it can be strongly argued that one of the major drivers behind the surging equity levels was clarity. Transparency on some of the major uncertainties surrounding the economy, which if unresolved, could have resulted in the exact opposite stock market scenario that we find ourselves in right now.
However, amidst all optimism in the first quarter of fiscal 2013, there has been a rather unusual development on the ETF space. Short term Bond ETFs have been witnessing huge inflows in their asset base for the quarter—however hard that might be to imagine (see Top Performing ETFs of the First Quarter).
The following table summarizes the biggest inflows in short term bond ETFs for the first quarter:
Funds Flow for Short Term Bond ETFs (1Q13)
Interestingly, out of the top 10 asset accumulators in the fixed income ETF space, 7 are short term bond ETFs. Also with a combined inflow of close to $9 billion for the top 10 asset accumulators, the short term bond ETFs account for close to $6.2 billion which is nearly 70%.
It is true this kind of behavior from investors was highly unlikely, given the excitement and optimism in the equity markets. Still, it should not be forgotten that the surging equity levels was viewed upon by a great deal of skepticism by many market participants on grounds of lack of fundamental support (see Banking ETFs: Laggards or Leaders?).
Also, the continuation of the Federal Reserve bond purchase program was put to question, which if halted would have resulted in falling bond prices. This was particularly true for bonds which target the longer end of the yield curve as they have the highest interest rate sensitivity.
Furthermore, the investment case for gold in the recent past has been lackluster to say the least. Also, going forward it is expected that the yellow metal will exhibit a near term weakness considering the attractiveness of equities. Also its movement in the near term would be better guided by the direction of the U.S. dollar. The U.S. dollar continues to gain in strength thanks to the devaluation of other developed market currencies (read British Pound ETF: Time to Buy?).
Therefore, the skepticism surrounding equities of ‘some’ players, the un-realistic risk-return tradeoff of long term bonds, and the sheer unattractiveness of gold have made short term bond ETFs exciting plays as “new safe havens’. This has transferred over into a surge in popularity, as evidenced by their impressive AUM accumulation totals in Q1.
Judging by these facts it can be said that the recent surge in popularity of the short term bonds is a direct result of an anticipation of a correction in equities. Still, it is very important to consider that this space is nothing more than a cash alternative investment offering almost zero yields and negligible possibility of capital appreciation.
However, if the case for short term bond ETFs as safe haven plays does prove to be correct, this space can witness even more asset accumulation going forward. This could be especially true if anxiety over lofty equity levels continues, or if a broader market pullback materializes, thereby increasing demand for these lower risk ETFs (see Corn ETF Continues Plunge).
Either way, considering the case for other safe investment avenues, short term bond ETFs definitely seem to be the safer safe havens, at least for the time being, and thus could continue to see inflows in Q2 as well.
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