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High-yield debt funds see record outflows and bonds rally

Part 4
High-yield debt funds see record outflows and bonds rally (Part 4 of 7)

Two major corrections evident in high-yield debt markets

Two corrections in high-yield debt markets

Investors pulled out of high-yield (HYG) mutual funds at a record rate, taking out $7.1 billion in a single week. This was the biggest weekly outflow ever for the asset class. This also marked the fourth consecutive weekly outflow. Net flows into junk-rated (JNK) mutual funds in 2014 are now in negative territory at ~$5.9 billion.

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A number of factors, both domestic and international, affected the pullback. On the domestic front, investors have shown increasing risk-aversion from junk-rated investments recently. As yields fell to all-time lows in June, many investors felt that valuations appeared stretched in this bond segment. Concerns voiced over signs of froth in the leveraged loans and high-yield bond markets by a number of Fed officials, including Fed Chair Janet Yellen, had an impact of investor flows.

Overseas credit markets also exhibited signs of stress. Argentina defaulted on its sovereign debt obligations, while prominent Portuguese lender, Banco Espirito Santo was embroiled in the debt woes of its parent company. The central bank of Portugal has since bailed out the lender. An increase in geopolitical risks due to the Middle East and Russia-Ukraine crises also affected investor sentiment.

Yields and spreads analysis for high-yield debt

Investor flows into mutual funds for various assets are key momentum indicators for the asset class. Although they typically lag market sentiment, they provide valuable clues for gauging investor behavior. Last week, although investors pulled out funds from high-yield mutual funds, broader market sentiment appeared to reverse.

Despite the adverse investor sentiment, yields on high-yield (HYG) debt and the spreads between high-yield debt (JNK) and Treasuries (TLT) fell over the week ending August 8. High-yield debt yields, as represented by the BofA Merrill Lynch U.S. High Yield Master II Effective Yield, decreased by 12 basis points to end the week at 5.92%.

The Option Adjusted Spread (or OAS) also decreased. The BofA Merrill Lynch U.S. High Yield Master II Option-Adjusted Spread decreased by five basis points to come in at 4.20% on August 8.

In the previous week—the week ending August 1—high-bond yields had increased by over 50 basis points, in reaction to the Argentinian and Portuguese credit crises. Last week’s decrease in yields and spreads may have been a correction to the market overreaction the previous week.

Yield had also increased significantly, by over 50 basis points, the previous week. More market-savvy investors could have seen this as a buying opportunity. Another possible explanation is fund redemptions using cash, staving off a further sell-off in high-yield debt (SJNK).

You’ll find more reactions of asset classes including those of stocks (SPY) and investment-grade bonds in Part 7 of this series. In the next section, you’ll read about how the changing market environment affected leveraged loans.

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