Why the demand in the high yield bond market rebounded last week
A positive funds flow
The high yield bond funds flow turned positive last week after a relatively small outflow the previous week, which broke the line of seven straight weeks of inflows.
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The funds flow totaled $493 million last week—an increase of $297 million from the previous week’s outflows of $196 million. The year-to-date funds flow remained at $3.3 billion, compared to the $548 million inflows over the same period last year.
With a net inflow, the trailing four-week average slipped to $331 million per week from $348 million the previous week and as high as $537 million per week three weeks ago.
In line with the increased high yield bond funds flow, major ETFs that represent nearly 80% of the high yield bond ETF market posted positive cash flows.
The iShares iBoxx $ High Yield Corporate Bond (HYG), with total assets of $13.3 billion, posted a net inflow of $98.9 million last week. One-month net inflows were $314.8 million, indicating overall bullish market activity. On the other hand, the SPDR Barclays High Yield Bond (JNK), with total assets of $10.4 billion, posted a net inflow of $47.9 million last week. The one-month net flow was negative at $25.7 million, but lower than the previous weeks’ outflow of $80.5 million.
The major difference between both the ETFs is of 50 basis point and 40 basis point expense ratio. Higher expense ratio generally lowers the net effective return, which includes the fees of a fund manager and other discretionary expenses to maintain the account. Credit ratings remain the dominant factor when choosing the right ETF. Both HYG and JNK invest in B rated bonds and have top holding in Sprint Corporation (S) and Hospital Corporation of America (HCA).
Theoretically, in the times of economic downturns, investors usually sell out of high yield bonds (JNK), particularly the low rated bonds, as they are less able to withstand the decline in the economy. However, in the current improving economic scenario, the markets seem to have been less concerned about the credit risk (aka default risk) of the high yield bond issuers. Rather, the biggest worry at present is the interest rate risk. With improvement in economy, the risk of inflation rises as people have more money to spend. Central bankers use monetary policy (that is, central bankers increase interest rates) to control inflationary risks. As bond prices and interest rates share an inverse relationship, bond prices drop with expectation of an interest rate rise.
Decline in the bond prices will hurt the existing high yield bond investors the most, as the investors will find it very difficult to sell off the bonds in the secondary market, unless they are ready to bear the capital losses. However, if the investors continue to hold the bond until maturity, they would receive the face value of the bond.
The present scenario in the high yield bond market suggests that the investors and fund managers will favor higher yields over the possibility of capital loss, as we saw a good funds flow transaction last week. However, this thinking changes with one investor to another with a change in the risk appetite. In the long run, risk-averse investors’ would look for options like leveraged loans (BKLN) and Treasury Inflation-Protected Securities (TIP) to negate the effect of an increase in the interest rates.