Fixed-term bond funds more than doubled their net inflows for 2023 compared with any other year, bringing in €60bn ($64bn) in net flows, a Morningstar report on fixed-term bond funds in Europe and Asia shows, writes Hannah Williford.
The influx built the total assets under management to €156bn as of January 2024, which outpaces both EUR diversified bonds and EUR government bonds sectors. Companies have also jumped on the trend, launching 284 fixed-term bond funds in 2023 with 900 strategies now operating. In 2022, just 145 funds were launched and €22.8bn of net flows entered the sector.
Shannon Kirwin, associate director of manager research for Morningstar, said: “In the current market, fixed-term bond funds seem to be hitting the sweet spot for investors who are eager to take advantage of higher interest rates but reluctant to take on the market risk associated with owning a traditional bond fund.
“While these products have mostly delivered on their promises to investors, it’s important not to overlook their risks. Some of these funds carry substantial exposures to risky asset classes like high-yield corporate debt and emerging-markets bonds, and defaults can—and occasionally do—occur in this category. Investors mistaking fixed-term bond funds for fixed-term bank deposits do so at their peril. That being said, a fixed-term bond fund that is managed in a diversified and risk-aware fashion, and sold at a reasonable price, can have a place in a balanced portfolio.”
Fixed-term bonds are designed to target securities such as investment grade or high-yield corporate bonds or higher-spread sovereign debt. In the final year, the bonds mature and principal is put in cash securities until the fund is liquidated. Investors typically purchase shares at the beginning of the fund’s lifetime and hefty exit fees discourage leaving before the fund matures.
Morningstar found the median fee as of the end of 2023 for fixed-term bond funds to sit at 0.73%, compared to 0.57% for EUR corporate bonds and 0.86% for EUR high-yield bonds.
“The median fixed-term bond fund charges fixed fees that are broadly similar with traditional active funds investing in the same universe,” Kirwin said.
“That’s disappointing, as these buy-and-hold portfolios typically require less ongoing monitoring and bottom-up security analysis than regular active funds where managers and analysts constantly reevaluate the composition of the portfolio.”
Kirwin also noted the concentration of fixed-term bond funds is higher than some of its peers, with an average of 69 unique bonds in the end of 2023 while actively managed EUR corporate bond funds hold an average of 242.
“Concentration thus remains a concern given these funds’ sizable exposures to risky asset classes like high-yield corporate bonds or emerging-markets debt,” Kirwin said.
“This concentration can make fixed-term bond funds more vulnerable to defaults than other, more-diversified options.”
This story first appeared on our sister publication, Portfolio Adviser.
