Investors dump UK funds and buy bonds

The UK stock market is underperforming this year, and bond yields are rising. Fund investors have positioned to benefit from the higher income on offer from fixed income. 

Bond funds attracted the most money from UK investors in May, as investors sought to tap into higher yields.

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

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Rising interest rates have sparked a repricing of bonds, with lower prices leading to higher yields. UK government bonds (gilts) now pay more than 4% across all maturity lengths, with bonds maturing in one and two years paying around 5.5%.

Investors willing to move into corporate bonds can get even higher income, with yields closer at 6.5% on average for investment grade bonds in sterling if held to maturity. The distribution yield, which is the income currently paid out by a fund, is lower due to portfolios still containing lots of lower coupon bonds.

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Demand for fixed income contrasts starkly with pessimism around UK funds. The worst-selling IA sector in May 2023 was UK All Companies, which experienced outflows of £916 million. UK funds overall saw outflows of £1.2 billion.

The FTSE All-Share, including dividends, is up 1.5% this year, according to data group FE Analytics. However, global shares, with dividends, are up 8.5%.

Global was the most popular investment sector in May, adding £261 million overall. Global funds are popular among interactive investor customers. Eight of the 10 most bought open-ended funds in June were global strategies, including Fundsmith Equity, Legal & General Global Technology, and Vanguard FTSE Global All Cap Index.

Tracker funds saw net inflows of £1 billion in May. Passive funds now have £292 billion under management, which is just over 20% of the funds industry in the UK.

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Chris Cummings, chief executive of the IA, said: “With ISA season behind us, modest inflows continued in May with £356 million invested into funds overall.  Caution was the theme of the month, with government bonds seeing strong inflows. This is not surprising given concern about potential global recession and ongoing conflict in Ukraine.

“Investors continued to diversify their equity portfolios, with continued inflows into global equity funds. However, North America had its first outflow in seven months, possibly reflecting uncertainty ahead of resolution on the debt ceiling. The UK remains unloved amid persistent outflows.”