Return Chasing in Bond Funds

Abstract

We use a unique dataset of SEC Form N-SAR filings to examine the gross flows of U.S. bond funds. We find that gross inflows and outflows average around 4% of total net assets per month, but net flows average only 0.26%. When modeling these flows, we see that, as with equity funds, bond fund investors chase returns. Most of the return chasing is done by inflows. Funds with the highest decile of returns average 1% higher net flow and inflow per month, and the lowest-decile funds lose nearly 0.6% in assets per month. Next, we find that positive net flows cause bond funds to diversify their holdings regardless of fund size. Finally, we test whether flows predict returns and find that an inflow-weighted portfolio generates alphas of 0.8% per year. Bond inflows appear to be “smart money.” <b>TOPICS:</b>Fixed income and structured finance, performance measurement