Corporate debt trends—have high yield investors had enough?

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High yield investors

In a key shift last week, investors exited high-yield bond (HYG) mutual funds, while piling into their corporate investment-grade (LQD) counterparts. On June 20, yields on high-yield bonds (BofA Merrill Lynch U.S. High Yield Master II Effective Yield) dropped to 5.18%—their lowest level ever. Is this the start of the end of the bull market in high-yield debt?

Part 1

Secondary market flows: Signs of froth? 

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While investor flows in high-yield and leveraged loans (BKLN) mutual funds were negative, investment-grade mutual funds reversed last week’s trend with net inflows of over $1.9 billion in the week ending June 18 (Source: Lipper). We had talked about the possibility of reversals in investment-grade flows this week in our last corporate bonds update.

What’s been surprising is that despite yields on high-yield (JNK) bonds falling to their lowest level ever in the week ending June 20, investors exited high-yield mutual funds, implying that either yields had fallen too low or that some investors don’t believe further upside is possible, at least in the near term.

A number of Fed officials have already cautioned on the low yields and spreads in high-yield debt markets. In an April speech at the Asia Society in Hong Kong, Dallas Fed Chief Richard Fisher said that junk-bond yields at below 5.5% were one of the “developments that give rise to caution.”

San Francisco Fed Chief John Williams, in a speech given on May 22 to the Association of Trade and Forfaiting in the Americas, said that “interest spreads for risky assets such as junk bonds and leveraged loans have grown quite narrow. That suggests that financial market participants who are awash in liquidity may be ignoring or taking on outsize potential risks.” Investors may be taking those warnings more seriously.

Primary market issuance

However, corporate borrowers in the primary markets continued to take advantage of the low yields environment. Total issuance in corporate debt primary markets, came in at c. ~$44 billion (Source: S&P Capital/LCD for HY & LL issuance, Bloomberg for IG issuance) in the week ending June 20, compared to c. ~$68 billion, the previous week.

We’ll analyze both primary and secondary market trends in greater detail in the following sections.

  • High-yield debt (Parts 2–4),
  • Leveraged loans (Parts 5–6), and
  • Investment-grade debt (Parts 7–8).

We’ll also discuss how returns on stocks (VOO) and high-yield debt can correlate. To learn more about why junk bond yields are at their lowest levels ever, please move on to the next section in this series.

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