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Bond fund flows turn negative again, this time with a vengeance

US High Yield Bond Fund Flows 2013-03-21Enlarge GraphBond fund flows were once again negative after a high positive spike the previous week. This time the negative outflow was more than the previous two weeks of negative outflows combined.

Fund flows help gauge the investor sentiment for an asset class by measuring the amount of money that flows in and out of different asset classes. Companies like Lipper track over $13 trillion worth of assets at different funds and offer frequent data quantifying the flows.

Inflows into high yield mutual funds show that investors are pumping money into the asset class, a sign of confidence in future prospects. On the other hand, when outflows start, or accelerate, it is a bearish sign showing that investors are leaving the asset class.

The outflows last week totaled $418 million, approximately half of the inflows the previous week. For the full year, cumulative funds are still positive (slightly below $300 million), though are likely to remain in the negative territory if we experience a couple more weeks with similar outflows.

Despite the outflows, the main high yield ETFs (e.g. HYG and JNK) were able to post a gain of 0.3% for the week, though the year-to-date returns are barely starting to turn positive after the steep drop in late January and early February.

The current uncertainty in Cyprus has scared investors, and if it indeed unleashes contagion that could ripple through the markets, then bonds would be a safer place than equities. The flip side, though, is that as credit risk increases, so will the spread between the Treasuries (risk free) and high yield bonds (rated below investment grade), which can more than offset any gains from contraction in Treasury yields given a global crisis.

One of the reasons for the high yield bond fund outflows is that lately investors have been switching into leveraged loans, which pay a floating rate (rather than a fixed coupon like bonds) and are therefore not exposed to a drop in price caused by a hike in interest rates. Since February, the possibility of reduced quantitative easing has had investors concerned since the Fed has been pumping over $80 billion a month to maintain the economy afloat.

Overall, outflows are a negative for high yield bond investors, which are compounded by the limited upside given the already historically low rates and threats of increased rates. The downside risk in the short term is likely low, though medium and long term there is no solid catalyst for further bond appreciation. The good side about bond investment, though, is the interest income stream currently yielding about 5% per year; a very similar interest yield can be achieved with leveraged loans (e.g. BKLN, SNLN).

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