Bond Funds Attract Most Money as Stock Market Lags Behind

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The UK stock market has shown weaker performance this year, while bond yields have been on the rise. As a result, fund investors have strategically positioned themselves to take advantage of the higher income opportunities offered by fixed income investments.

In May, bond funds attracted the highest amount of money from UK investors as they aimed to tap into the attractive yields.

The Investment Association (IA), the trade body for the funds industry, reported that government bond funds witnessed net inflows of £658 million, short-term money market funds added £382 million, and gilt funds received £344 million.

The increase in interest rates has triggered a repricing of bonds, leading to higher yields. UK government bonds, also known as gilts, now offer yields of more than 4% across all maturity lengths, with bonds maturing in one to two years providing yields around 5.5%.

Investors who are open to considering corporate bonds can enjoy even higher income potential, with investment grade sterling bonds offering an average yield of approximately 6.5% if held until maturity.

However, the distribution yield, which represents the current income paid out by a fund, may be lower due to portfolios still holding a significant number of lower coupon bonds.

The strong demand for fixed income investments sharply contrasts with the prevailing pessimism surrounding UK funds.

In May 2023, the UK All Companies sector experienced outflows of £916 million, making it the worst-selling sector. Overall, UK funds witnessed outflows of £1.2 billion.

According to data from FE Analytics, the FTSE All-Share has recorded a modest 1.5% increase this year, including dividends. In contrast, global shares, including dividends, have seen a rise of 8.5%.

Caution was the prevailing sentiment during the month, evident in the substantial inflows into government bonds. This response is not surprising given concerns about a potential global recession and the ongoing conflict in Ukraine.

Investors continued to diversify their equity portfolios by directing further investments into global equity funds. However, North America experienced its first outflow in seven months, possibly reflecting uncertainty surrounding the resolution of the debt ceiling. The UK market remains unappealing, characterized by persistent outflows.

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