Return Chasing in Bond Funds

We make use of a unique dataset of SEC Form N-SAR filings to examine the gross flows of U.S. bond funds. We find that gross inflows and outflows average around 4% of TNA per month, but net flows average only 0.26%. When modeling these flows, we see that, like equity funds, bond fund investors chase returns. Most of the return chasing is done by inflows. Funds with the highest decile of returns average 1% higher net flow and inflow per month, while the lowest decile funds lose nearly 0.6% in assets per month. Next, we find that positive net flows cause bond funds to diversify their holdings regardless of fund size. Finally, we test whether flows predict returns and find that an inflow weighted portfolio generates alphas of 0.8% per year. Bond inflows appear to be “smart money.”