Investors are shifting into this type of bond fund at the fastest pace in three years

Published Fri, Jan 26 202411:20 AM EST

Jesse Pound @/in/jesse-pound @jesserpound

Investors are making a big shift in their bond portfolios to kick off the new year, a sign that optimism around inflation and rate cuts is turning into actionable trading decisions. Bank of America credit strategist Yuri Seliger said in a Jan. 24 note that high grade credit funds are on track for their biggest monthly inflows since January 2021. "Bond fund / ETF flows tend to follow returns with about a month lag. Therefore, the big rally in interest rates during November and December has resulted in a big inflow to high grade in January," Seliger said. Bond yields move opposite of price. The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) is the top bond ETF by inflows with more than $4.5 billion month to date, according to FactSet. The inflows have come even though the fund is down about 1% in January. LQD YTD mountain The LQD ETF is seeing heavy demand from investors but is still down in January. Another notable fund is the Vanguard Intermediate-Term Corporate Bond ETF (VCIT) , which has brought in more than $2 billion. "People have definitely been allocating to investment grade. That is the biggest flow we've seen this year," said Stephen Laipply, global co-head of bond ETFs at BlackRock. In 2023, investors were heavily invested in safe short-term assets like money-market funds relative to recent history, and the shift into investment grade credit may be a sign that behavior is changing as a potential "soft landing" for the economy seems more likely. "Investment grade is a way to extend into fixed income and take some risk, without going all the way into high yield or [emerging market debt]," Laipply said. He added that institutional investors like insurance companies have been a notable source of demand for corporate bonds recently. How fixed income investors react to expected rate cuts from the Federal Reserve is a key question in 2024. When the Fed was hiking rates, the yield curve inverted, so investors piled into short-term vehicles like money market funds to get higher payouts and protection against the bond price impacts of the hikes. But now that inflation has cooled to near the Fed's 2% target and rate cuts are expected, investors may be looking outside of ultra-safe funds to get more yield. Major iShares funds tracking long-term Treasurys ( TLT ) and short-term Treasurys ( SHV ) have both seen outflows so far this year. "I think what people might be concerned about is if the Fed starts cutting rates, does that 4% go lower? So now you want to try to allocate while you still have yields at these levels," Laipply said.