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Investors flee bond funds in anticipation of higher rates

Investors flee bond funds in anticipation of higher rates

UK investors withdrew £327m from bond funds in the Investment Association (IA) sectors in June.

The market had priced in a 90 per cent chance of the Bank of England raising UK interest rates to 0.75 per cent today (2 August) which has caused investors in bond funds to head for the exit.

These outflows compared with inflows of £368m into the asset class in May.

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Many bonds would be expected to fall in price as rates rise because higher interest rates on cash deposits forces those issuing new bonds to offer a higher interest rate to maintain the gap between the return available on the low risk option of cash, and the higher risk bond option.

As a result of new bonds coming to the market offering a higher rate of interest, the prices of existing bonds at a lower rate would fall in price due to lower demand. That is how, when bond yields rise, bond prices fall.

That means many of the the assets currently held in bond funds will fall in value if UK interest rates rise.  

There were also signs that sentiment towards UK equity funds was shifting as investors withdrew £280m in net outflows in June, compared with the £1.2bn withdrawn from UK-focused funds in May.

Mixed asset funds topped the sales chart in June with net inflows of £430m, while global equity funds were the most popular equity investment, attracting inflows of £291m.

Caspar Rock, chief investment officer at Cazenove Capital, said that while many equity investors had declared the UK stock market to be cheap due to the dominance of companies with overseas earnings, he believed the sectors that provide the income, such as mining and oil, were themselves bad value.

Laura Suter, personal finance analyst at AJ Bell said: "Investors are preferring to put their cash overseas, pegging their fortunes on higher growth nations. America has been the biggest beneficiary, with the tax cuts and strong economy drawing investors in, who allocated almost £250m to the US in June.

"Total assets under management stayed pretty flat in June, falling by 0.5 per cent, but investors are clearly not bullish on markets as they put 75 per cent less money into investment funds when compared to June last year.

"With interest rates rising, it will be interesting to see in next month’s figures how investors react to this news and whether they shift their allocations back into UK equity funds amid hopes of a stronger economy."

david.thorpe@ft.com