Nearly 300 fixed-term bond fund launches were recorded last year as the investment category took in large flows from investors seeking exposure to higher interest rates.
However, Morningstar warned that investors might be unaware of the risks due to “misleading” marketing by fund providers.
The firm said there were 284 unique fund launches in 2023 bringing the total of fixed-term bond funds to 900 strategies.
Fixed-term bond funds are often marketed to investors as being similar in nature to fixed deposits, a “misleading comparison that downplays their level of credit risk”, Morningstar said.
Exposures to high-yield and emerging-markets bonds are significantly higher than conventional open-end funds in Morningstar’s corporate and diversified bond-fund categories, leaving some funds vulnerable to default risk and the risk that investors could withdraw funds early.
Shannon Kirwin, associate director, manager research, Morningstar, said: “In the current market, fixed-term bond funds seem to be hitting the sweet spot for investors who are eager to take advantage of higher interest rates but reluctant to take on the market risk associated with owning a traditional bond fund. While these products have mostly delivered on their promises to investors, it’s important not to overlook their risks.
“Some of these funds carry substantial exposures to risky asset classes like high-yield corporate debt and emerging-markets bonds, and defaults can—and occasionally do—occur in this category. Investors mistaking fixed-term bond funds for fixed-term bank deposits do so at their peril.”
Fixed-term bond funds managed in a diversified and risk-aware fashion, and sold at a reasonable price, can have a place in a balanced portfolio, she added.
Investors placed a net €60 billion in these funds over 2023 – more than twice the level of any previous calendar year, Morningstar said in its ‘Fixed-Term Bond Funds in Europe and Asia’ report.
The firm described the popularity of fixed-term bond funds’ as having “exploded” in 2023. Total assets under management in the category reached €156 billion, as of January 2024, and some 93% of euro-denominated fixed-term bond funds outperformed the euro diversified bond and euro corporate bond Morningstar Category averages over their lifetimes.
A slimmer majority of US-dollar-denominated fixed-term bond funds outperformed their dollar diversified bond and corporate bond peers.
More recently, said Morningstar, cheap, diversified, and transparent fixed-term ETFs have become available from a handful of passive fund providers. While still in their infancy, these products provide investors with a more predictable way to access the fixed-term bond market at a fraction of the cost.
