Latest figures from the Investment Association show that retail investors continued to invest heavily in bond funds in November, despite an interest rate rise. Contributor Laith Khalaf, Senior Analyst – Hargreaves Lansdown

Within equity funds, Europe and Asia were the bright spots, with money still flowing out of the UK. Tracker funds had their worst month for a while, registering only £171 million of net new sales. Institutional investors proved more skittish than their retail counterparts, withdrawing £449 million from funds in November.

Laith Khalaf, Senior Analyst, Hargreaves Lansdown: ‘It’s hard to fathom why bond funds have gained such popularity at a time of rising inflation and tightening monetary policy, both of which make wringing returns out of an already fully-priced fixed income market look like an uphill struggle.

Portfolio rebalancing is one possible answer, as investors may have taken profits on equities and topped up their bond holdings to maintain their preferred asset allocation. In addition, after ten years of ultra-low interest rates, perhaps some cash investors have finally given up the ghost and traded up the risk spectrum in search of a higher income.

Earlier this week, bond guru Bill Gross called the start of the bond bear market, though in January 2010 he also told us that the UK gilt market sat on a bed of nitroglycerine, at which point yields were three times higher than they are today. To be fair, he wasn’t alone, and hindsight is a wonderful thing.

Today, monetary policy looks like it is going to tighten very slowly, which suggests the bond bubble may deflate rather than burst. However that’s still going to make turning a profit on bond investment more challenging.

Bonds do provide some diversification to a portfolio in case things don’t go as swimmingly as planned, after all, monetary policy can go in both directions, even at these low levels. Perhaps therein lies the rub – there is a great deal of negativity towards the UK, as evidenced by continued withdrawals from UK equity funds. This pessimism may well be manifesting itself in bigger bond inflows, as investors seek to protect against some of the risk that they see emanating from the Brexit negotiations and a weak government.

Despite withdrawing money from UK equities, investors have shown themselves willing to invest in international stock markets, particularly Europe and Asia. This continues a trend we saw throughout last year as investors looked overseas to fill up their equity boots.

Tracker fund sales stuttered in November, though the secular growth in passive vehicles still has some legs in it, particularly with pension auto-enrolment increasing the flow of money into default funds. It’s perhaps no coincidence that in November weak sales were recorded in both tracker funds and the North American sector, seeing as the efficient US stock market is a prime candidate for passive investment.

Furthermore, in an environment where there is some concern over stock market valuation, particularly in the US, it’s not too surprising to see some reallocation away from passive vehicles towards more active strategies.’