Investor Sentiment in the Equity Market and Investments in Corporate-Bond Funds

Abstract

This study explores the relation between investor sentiment in the equity market and investments in corporate-bond funds. Investors tend to move into and out of corporate-bond funds when contemporaneous investor sentiment in equity market differs from historical average. Specifically, a one-standard-deviation decrease in equity-market sentiment generates 0.1% and 0.4% inflows for active and index funds, respectively. It reflects the time varying flight-to-safety behavior of investors. However, the corporate-bond funds with negative or low exposure to equity-market sentiment appear to attract inflows and funds with positive or high exposure to equity-market sentiment experience outflows, indicating that investors are likely to avoid sentiment risk. Out-of-sample analysis shows that corporate-bond funds with the highest negative sentiment exposure significantly outperform the funds with the highest positive sentiment exposure by 2.22%-2.52% per year. The results are pervasive across active and index funds, present in different periods and robust to using composite sentiment metrics.