Pimco vs Vanguard: the numbers tell the story

The changing of the guard among bond funds - Vanguard has just surpassed Pimco as the manager of the world largest bond fund - has its roots in two places - the growing attraction of low-cost index tracking funds and the management troubles at Pimco.

The first chart below shows how investors have deserted Pimco's Total Return fund since its funds under management peaked at $293bn in April 2013 to sink to a new low of $110bn at the end of last month.

At the fund's peak, Bill Gross still reigned supreme as the bond market king. Customer withdrawals began that year, but they accelerated amid management turmoil. Mohamed El-Erian, co-chief investment officer, left in January 2014 amid tales of angry confrontations with Mr Gross, who then jumped ship to Janus Capital in September. The prospect of monetary tightening by the Federal Reserve has also played a part in Pimco's woes, but investors have continued to pour money into other bond funds, including those managed by Vanguard. Vanguard Total Bond Market Index Fund hit $117.3bn last month.

The second chart shows the split between active and passive US mutual funds and exchange traded funds, and the growing share of investor money that has gone to the latter.

Since the global financial crisis prompted quantitative easing in the US, Japan and now the EU, investors appear to have taken the view that central banks are running the show and they might as well put their money in a passive fund rather than pay more for an active manager whose portfolio may be at the risk of being wrongfooted by the Fed. US investors pay just 7 basis points to hold Vanguard's flagship bond fund, while Pimco charges 0.85 per cent - more than 10 times as much. Vanguard now runs both the biggest equity fund and the biggest bond fund.

Chart number three shows the strong investor preference for bond funds over equity funds in the US up to mid-2013, when the Fed first indicated its intention to wind down its $10bn a month bond buying programme. Since then, flows into both asset classes have been volatile.

Chart four tracks the long-term decline in US inflation and bond yields. Since bond prices move inversely to yields, this has been the primary reason behind the strong performance of fixed income investments over recent years.

The question now is what happens next: there is little sign of a pick-up in inflation, and markets now have low expectations of a Fed rate rise this year. When that rate rise happens, bond prices are likely to fall. However, so far, the long-expected bond market crash is still waiting in the wings.

The last chart shows why the bond market is more likely to deflate slowly rather than crash when rates rise. While some investors will sell off their bonds, demographics should provide a cushion. A rising tide of baby boomers are likely to continue to rely largely on bond investments to provide an income in retirement. That steady flow of money into the bond market will help to support prices.

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