Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

This is the year investors revolted.

They put their collective foot down and demanded simple, cheap funds that track market benchmarks. They shunned expensive, human decision-making after finding such a personal touch wasn't all it was cracked up to be.

A good example of this can be found in so-called nontraditional bond funds, which are poised for their biggest year of withdrawals ever. Investors have yanked $18.3 billion from these funds this year through August, building on last year's $13.4 billion outflow, according to Morningstar data.

Boom and Bust
Investors are fleeing from non-traditional bond funds that sought, and failed, to outperform
Source: Morningstar
2016 data through August

These funds are seeing the biggest withdrawals of any open-ended debt-fund types tracked by Morningstar this year. Intermediate-term bond funds, meanwhile, have received $71.8 billion of inflows.

Full Spectrum
Investors have plowed into broad bond funds even as they withdraw from less-traditional funds
Source: Morningstar

What a difference a few years makes. In 2013, these so-called go-anywhere funds were all the rage, attracting $47.9 billion as many investors sought ways to hedge against rising interest rates. But interest rates never rose -- quite the contrary. Benchmark borrowing costs fell significantly, spurring big gains on debt of all types. And while the Fed has begun raising rates, it's clearly in no rush.

Head Fake
Benchmark bond yields have fallen since 2013, even though investors had prepared for them to rise
Source: Bloomberg

In the meantime, these nontraditional funds haven't done well relative to other asset classes, which have generally surged in response to central-bank stimulus. The funds have gained 4.4 percent, on average, so far this year, compared with 10.2 percent for U.S. junk bonds and 10.8 percent for global developed-market sovereign debt. Over the past three years, the annual return on the funds has averaged 2 percent, substantially less than traditional bond funds of various types, according to Morningstar data. 

The shift away from human judgment toward passive funds may leave investors more exposed to any unexpected increase in yields. But no longer are investors willing to accept the black-box approach to investing, where they just trust money managers will make the right decisions. They've already tried that. And for the most part, it hasn't worked out so well.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net