“Davidson” submits:

This article shows why fixed income ($UST) is such a dangerous investment at this point in the business cycle. Losses can come very, very quickly once enough investors decide to shift funds out of fixed income for higher returns elsewhere.

The safest area for returns the next several years is equity ($SPY) even with the high volatility. As long as the global economy is improving, equities have historically gained favor in spite of volatility. This causes fixed income to sell off as investors chase returns and rates rise causing substantial losses for those who do not make the shift.

 

Wipeout in Europe Bond Funds Tests Investors’ Resolve

Recent rout in government debt pummels funds’ strong start to the year

A strong start to the year for many of Europe’s biggest bond funds was all but wiped out by an abrupt selloff in the region’s credit market, testing the mettle of investors who rely on the asset class for its steady returns.

Europe has been at the center of the global bond-market turmoil that began in mid-April. About €344 billion ($375 billion) was wiped off the value of eurozone-government bonds when prices fell abruptly after rising for several months to record levels, according to Bloomberg News’s index of eurozone sovereign bonds, which tracks the value of the bonds outstanding in the currency bloc.

“Fixed income had a great ride for a long time, but in the last few weeks we have lost a lot of money,” said Tanguy Le Saout, head of European fixed income atPioneer Investments.

Pioneer’s flagship €4.9 billion aggregate bond fund was up 3.1% in the first quarter, before losing much of that, according to data provided by fund-research firm Morningstar Inc. It was up 0.7% from the start of the year through Tuesday.

Investors say it isn’t clear exactly what triggered the selloff in government bonds. Most agree prices had climbed too far, too fast, as buyers swooped in to capitalize on the European Central Bank’s €60 billion-a-month bond-buying program, which was announced in January and began in early March.

Many agree bond prices climbed too far, too fast, as buyers swooped in to capitalize on the European Central Bank’s bond-buying program.

As prices rose, reducing yields, buyers were increasingly exposed to signs that inflation, which erodes the value of bonds over time, was picking up from ultralow levels. Traders say that hedge funds began dumping eurozone debt, and buyers weren’t willing to step in.

The market has steadied in the past two weeks, helped by news that the ECB willbring forward some of its bond buying ahead of an anticipated summer lull in markets. Benchmark 10-year German yields fell back to 0.533% Thursday after spiking to 0.77% in mid-May, according to Tradeweb.

“It’s certainly been very exciting,” said Olivier de Larouzière, who manages the €1.9 billion Souverains Euro fund at Natixis. “But we couldn’t anticipate the violence of the move and weren’t able to protect our funds.”

The fund is up 0.7% this year, after gaining 4.3% in the first quarter.

Still, Mr. de Larouzière isn’t nervous that investors will pull their cash out of his fund. It has gained more than the average of 0.5% for eurozone government-bond funds tracked by Morningstar. “We have lost everything, in absolute terms. But in relative terms, it’s been positive.”

Still, the decline has proved too much for some investors, many of whom see government bonds as the steadier part of their portfolios, providing a counterweight to riskier assets such as stocks.

More than $2 billion was pulled from eurozone-bond funds over the past six weeks, the first significant period of outflows after a year of broadly stable assets, according to EPFR Global, a fund-data provider.

“People expect fixed-income funds to have a positive return, and the recent selloff is questioning that,” said Pioneer’s Mr. Le Saout.

Many investors expect bonds to fall further as the eurozone economy continues to improve and inflation picks up, causing buyers to balk at ultralow yields.

“We expect rates to go up. Growth is coming back. [ECB stimulus] seems to be working,” said Andrea Giannotta, who manages a €3.7 billion long-term euro fund at Eurizon Capital.

The fund—which focuses on long-dated bonds, hit by the wildest swings— is up 0.7% in 2015, having risen 6.7% in the first three months of the year. He has recently reduced the average maturity of bonds in his portfolio to damp the effect of further volatility.

But Mr. Giannotta isn’t expecting an accelerating exodus from longer-dated debt. Many investors, such as pension funds and insurance companies, are forced to hold such bonds to balance their long-term liabilities. And other buyers are likely to continue to be attracted by higher yields than are available on shorter-dated debt, he said.

“Investors are waking up after a nightmare,” Mr. Giannotta said. “But you have no choice: To get a better yield, you have to run a risk.”