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Lessons of the Fear Trade 

Kristina Hooper 

The Upshot 


An exodus out of bond funds reveals the anxiety triggered by the recent rise in Treasury yields. But with a lot of that money going to cash amid rock-bottom rates, investors are trading one threat for another, writes Kristina Hooper.

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Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

Fear is a powerful force, especially when it comes to investing. It can cloud your judgment and make you do things that hurt your chances at achieving your goals. But pushing past the fear to gain perspective on the way we look at risk can help keep those goals on track.

The latest data on mutual fund flows is a good example. June was the worst month on record for outflows of open-end bond funds, according to Morningstar. An estimated $60.2 billion was pulled from bond funds—$43.8 billion from taxable bond funds and $16.4 billion from non-taxable bond funds. The scenario was similar for ETFs, where we saw significant net outflows of bond ETFs. But contrary to what many market watchers might have expected, very little of that money shifted into riskier assets such as stocks. High-yield open-end bond funds also saw net outflows while open-end stock funds garnered only $7 billion in net inflows and equity ETFs saw net outflows.

Where's the Money Going?

So where did all the money go? It appears to have gone to cash. Data provided by the St. Louis Fed shows that between May 27 and July 8, bank savings deposits have risen nearly $100 billion. It's been said that people go to greater lengths to avoid what they fear than they do to obtain what they desire. This move into cash has been motivated by fear. Investors finally saw firsthand the risks inherent in holding core fixed income when rates rise, so there was a mass exodus out of bond funds in June.

But rather than recognize some of the other dangers present in an environment of financial repression, they moved much of their money into cash and cash equivalents, another area that carries significant risks. This allocation decision puts long-term investing goals in jeopardy.

Marie Curie once said, "Nothing in life is to be feared, it is only to be understood. Now is the time to understand more, so that we may fear less." In the spirit of understanding more, we can't stress enough that just because the Federal Reserve has made it clear that tapering may begin soon, it does not mean that financial repression will end. It just means that the Fed will dial down one aspect of it. Expect financial repression to last for years to come as the US economy and many developed economies attempt to stimulate growth and de-lever their high public debt.

Don't Underestimate Inflation

It's also important to remember how financial repression has redefined risk and reward for different asset classes. Specifically, cash carries some very distinct threats. While the potential for Fed tapering in the near future appears to be making investors less concerned about inflation, it's a mistake to underestimate the threat it poses. Inflation is low now but it can spike without warning. Here are three reasons to pay attention to inflation:

Real returns on cash and cash equivalents are negative now despite low inflation.

Inflation could increase in the medium term, as the economy improves, exacerbating negative real returns.

Just as the government seeks to erode the real value of its debt through financial repression, cash and cash equivalents will see their real value eroded as well.

A financially repressive environment is not a favorable one for investors who are overexposed to cash. As much as fear might move investors further away from risk assets, an understanding of how financial repression hurts savers and low-yielding investments should coax them to move further out on the risk spectrum. Choose fight over flight. That's the path to reaching your financial goals.

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The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.

A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.

Allianz Global Investors Distributors LLC, 1633 Broadway, New York NY, 10019-7585,, 1-800-926-4456.


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