Why high-yield debt funds see record outflows and bonds rally



High-yield and leveraged loans update for the week ending August 8

It’s been a rollercoaster ride for U.S. bond markets lately, especially if you’re a high-yield debt investor. The last couple of weeks saw some wide swings as both domestic and overseas events made their impact felt on both bond (BND) and stock (SPY) markets.

Part 1

Impact of domestic and overseas risk factors

Credit and geopolitical risks perceptions increased over the past few weeks. Both overseas and domestic risk factors were apparent. During turbulent times investors generally prefer to park their funds in safer assets—for example, U.S. Treasuries and precious metals like gold (GLD) and silver.

While investment-grade bonds funds benefited from rising market jitters, high-yield bond funds bore the brunt. Last week, investors pulled a record $7.1 billion from high-yield bond funds—the largest weekly outflow ever (Source: Lipper).

What’s the silver lining for high-yield debt investors?

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Investor flows into mutual funds for various assets are key momentum indicators for the asset class. They provide valuable clues for gauging investor behavior. Investor flows also typically tend to lag market movements. Last week, although investors pulled out funds from high-yield mutual funds at a record pace, high-yield debt markets provided positive returns.

Yields on high-yield (HYG) debt 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%. Since yields and bond prices move in opposite directions, high-yield bonds (HYG) clocked in price gains.

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

The lower bond prices may also have represented a buying opportunity for more market-savvy and risk-inclined investors. As long as the monetary policy is expected to stay accommodative—a low interest rates environment—investors with a higher risk appetite would continue “reaching for yield.”

Another possible explanation for the upturn in high-yield debt (JNK) markets may be that bond mutual funds used cash for funding redemptions, staving off a bigger sell-off in high-yield bonds. Some of these factors may cause flows to reverse this week.

These factors also had a profound impact on junk bond issuers in the primary market. You’ll read about their influence in the next section.


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