The federal shutdown's impact on high yield bonds

Part 4

Investors shift from loans to high yield bonds as tapering delays

Fund flow reversal

Last week, fund flows showed a reversal in high yield bond flows, which coincided with the loss of momentum in flows to leveraged loans.

US Leveraged Loan Flows 2013-10-09Enlarge Graph

Inflows steady, but weak relative to previous weeks

The inflows for leveraged loans for last week carried on at the same $750+ million pace as the previous week. While this level of inflows remains healthy, the pick up in high yield bond flows reflects the change in investors’ sentiment. Year-to-date inflows for loans are now close to $45 billion and the asset class closed its 68th straight week of inflows.

However, the recently stronger inflows were the result of investor expectations around tapering. Since the Fed decided to delay tapering in September, investors once again focused towards high yield bonds and less so on leveraged loans. The reason for this is that high yield bonds can offer slightly higher returns, albeit at a slightly higher risk. Nonetheless, both are below–investment-grade securities.

With the government shutdown extending into its second week, the risk-off mentality is moving investors towards safe assets, which is lowering yields on Treasuries and, as a result, lowering the yield on bonds and hence bond prices are up. While bonds do carry a spread risk given their below–investment-grade rating, most investors are assuming that the economy won’t completely tank, as the shutdown should resolve shortly.

Loan issuance has taken a beating lately as well, but the key driver of returns for both loans and bonds may be a combination of the length of the shutdown and Q3 earnings. Read on to learn more.

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