High yield bond flows take a U-turn

US High Yield Bond Fund Flows 2013-06-04Enlarge Graph

May closed as the most volatile month so far this year for high yield bond flows.

Fund flows are key to understand investor sentiment since they show whether investors are moving cash into or out of the asset class. Once the cash is in, it needs to be invested, which will boost prices as fund managers buy securities to put the money to work. By the time the cash is out, prices have dropped already as managers had to sell positions to return cash to investors.

Strong reversals, such as the one last week, send clear messages to the market. May started strong, building up on the momentum from mid-April, but then a $400 million hiccup drew hopes away, just to be almost completely reversed the following week. Then last week, almost $0.9 billion fled the high yield funds.

Outlook

JNK, for example, has returned over 7.5% year-to-date, though that is down from a high of almost 12% in early May. The returns for HYG are about 0.3 percentage points behind, but following the same behavior.

Those investors caught off-guard are better suited switching to leveraged loans (e.g. SNLN, BKLN) to avoid further losses due to interest rate risk, as there may be a high chance that prices will not recover. Prices dropped as investors started pricing in the probability of an earlier than planned rise in interest rates.

While there may be a slight pull-back in the very short-term, it is likely that a strong downtrend was just born.