NEW YORK -- Looking for reasons to think the bond market rally isn't over?
Here's one: Some traditional buyers of bonds in previous rallies haven't joined this one yet -- mutual fund investors. History shows that bond market rallies usually don't end until people pour money into bond funds.
Edward S. Hyman, president of ISI Group Inc., a New York money management and economic consulting firm, published a report this month studying the relationship between bond yields and bond fund sales since 1984. The study found that bond markets struggle when investors pull money from bond funds and bond returns improve when investors start pouring money into bond funds.
In 1993, for example, a net $113.7 billion was invested in bond funds and the bond market rose 11.35 percent on a total-return basis; in 1986, a net $108.6 billion was put in bond funds and government bonds surged 17.21 percent on a total-return basis.
In contrast, last year a net $43.4 billion was pulled from bond funds, the Investment Company Institute said, and the U.S. bond market fell 5 percent on a total-return basis, the biggest one-year loss since 1949.
Redemptions continue this year. Individual investors withdrew a net $7.7 billion from bond funds in the first four months, even as U.S. government bonds rose 10.7 percent on a total-return basis. The average taxable bond fund is up 8.8 percent this year, while the average stock fund is up 13.45 percent, Lipper Analytical Services Inc. says.
If Mr. Hyman's research is accurate, this year's bond market rally is being restrained by an absence of mutual fund buying.
"The fact that people aren't pouring money into bond funds indicates to me that the bond rally has further to go," said Pat Retzer, manager of the $65 million Heartland U.S. Government Securities Fund.
To be sure, when money really starts to pour into bond funds, it's often a sign the bond market is peaking. Between October 1992 and October 1993, for example, a net $118.9 billion was invested in bond funds as the government bond market soared 14.4 percent on a total-return basis.
The heaviest buying was in July and August 1993, when $25.6 billion was poured into bond funds, just before the yield of the 30-year bond hit a record low of 5.79 percent in October, the lowest level since the Treasury started selling these bonds regularly in 1977.
"The rally will end when money starts pouring into bond funds," said Mr. Hyman, who predicts the 30-year bond yield will fall to 6 percent. The yield now is about 6.74 percent, down from 7.88 percent at the beginning of the year.
Fund companies report that investors are still wary about buying bond funds after what happened when the market slumped. "After last year's bond market rout, people are much more comfortable buying stock funds," Mr. Retzer said.
There are hints, however, that fund investors are starting to buy. Fidelity Investments, the nation's largest fund group, said a net $98 million worth of taxable and tax-free bond funds were purchased last month, up from $45 million in April.
Sales of T. Rowe Price Associates Inc.'s bond funds were positive in May, although down slightly from April.
Scudder, Stevens & Clark Inc. reported just the opposite. Scudder said its bond funds suffered net redemptions in May for a 16th straight month.
"Smart investors were buying bond funds last October when yields were peaking," said Randall Merk, senior vice president of the Benham Group, which oversees about $11.2 billion in bond fund investments. "Those buyers were few and far between."
Today, most investors prefer to buy stock funds, where returns average more than 10 percent this year, and certificates of deposit, where yields run as high as 6 percent, Mr. Merk said. Bond funds still aren't going to attract a lot of buyers until the bond market proves this year's market rally is sustainable, he said.
Robert Schumacher, the chief fixed-income strategist for $20 billion of bond funds at Kemper Financial Services, said money won't be flowing back to government bond funds for quite a while. That doesn't mean the rally will end anytime soon, he said.
As the rally continues, investors will be forced to get on board even if the funds they manage aren't getting new cash, Mr. Schumacher said. At the least, the fund manager will need to reinvest the interest income the fund earns.
Individuals now favor corporate and junk bond funds to government funds, Mr. Schumacher said. Government bond funds were trounced last year even though they were marketed by many companies as safe investments.
If the individual is paying for professional management, he figures he might as well take some risk by buying a corporate bond fund, Mr. Schumacher said.