The prolonged low interest rate environment has prompted investors to seek out riskier assets, like high yield. Matt Tucker explains why it’s important to know what you own when it comes to this segment of the bond market.
Much has been written about today’s prolonged low interest rate environment and how it has prompted many investors to seek out riskier assets in an attempt to generate a return that exceeds inflation. One big beneficiary of this trend has been high yield. In recent years, high yield mutual funds and ETFs saw massive inflows, and were beginning to appear expensive.
Market Realist – Fund flows in high yield bonds have turned negative
The US economy went into deep recession after the financial crisis. This prompted the Fed to keep an ultra-loose monetary policy. The Fed introduced QE (quantitative easing), a bond-buying program wherein the Fed aggressively purchased Treasuries (TLT) and MBS (mortgage-backed securities) to pump money into the economy. This caused an artificial scarcity of Treasuries, lowering yields to a record low.
Treasury yields remained low, so investors started looking for yield elsewhere. Investors tapped into riskier assets like high yield bonds and equities (SPY), driving their values higher.
The graph above shows the fund flows for the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) over the last eight years. Fund inflows peaked at close to $4.5 billion in 2012. This is when high yield bonds started looking expensive.
The fund saw outflows over the next two years. Crude oil (USO) prices started slumping in late 2014, and this adversely affected high yield bonds in the energy sector (XLE). Massive outflow from high yield bonds resulted, as investors feared a default cycle.