The fund flows reaction to last week’s high yield bond market

Market Realist

Interesting week for high yield bonds, leveraged loans see little activity (Part 4 of 7)

(Continued from Part 3)

Weekly fund flows are a great momentum indicator that can signal changes in investor sentiment. When fund flow increase, it suggests that the institutions and individual’s investment in the high yield debt have increased and vice-versa. As seen from the chart below, the past four weeks suggest continued bullishness in the high yield bond market (JNK). Risk averse investors favored the market despite the fear in the rise of the long-term interest rate with the onset of tapering. The Fed has clearly indicated that they will not increase the interest rate until the unemployment level reaches the 6.5% threshold, which is currently at 6.7%. Plus, a substantial amount of fund outflow from the emerging markets (EEM) landed to the U.S., which made their ways to Treasuries, corporate bonds and high yield bonds.

High yield bond fund flows increased by 18% to $560 million last week. The year-to-date fund flows were $1.9 billion, $1.3 million higher than $669 million over the same period last year.

The high yield bond prices declined last week on a reaction to the increase in the U.S. ten-year Treasury yields. The credit spreads paid by the high-yield issuers were also low relative to the historical average, but they seem more than sufficient considering the low default profile.

The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) price was down by 9%, while the SPDR Barclays Capital High Yield Bond ETF (JNK) price declined by 1%. The total return on the Bank of America Merrill Lynch U.S. High Yield Master II Index was slightly down, and the yield was up by 11 basis point.

In line with the fund flow trend in the high yield bond market, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) reported a weekly inflow of $71.4 million. One-month inflow was $111.7 million. The ETF with the gross expense ratio of 0.50% tracks the performance of iBoxx $ Liquid High Yield Index, a corporate bond market index compiled by the International Index Company Limited. The ETF year-to-date return is 1.16%.

The SPDR Barclays Capital High Yield Bond ETF (JNK) with relatively lower gross expense ratio of 0.40% posted a solid year-to-date return of 5.63%. The ETF tracks the performance of the Barclays Capital High Yield Very Liquid Index for high-yield (Ba1/BB+/BB+ or below) rated bonds. JNK posted a weekly outflow of $49.0 million, whereas, one-month fund inflows were $57.7 million. Both the ETFs has top holdings in Sprint Corporation (S) and Hospital Corporation of America (HCA).

Outlook

Given the fact that the Fed will not increase the interest rate in the near future, not until the year 2015, and also, the tensions prevailing in the emerging markets, high yield bond market currently remains bullish. However, if the Fed will start raising interest rates, which would depend on two conditions–resurgence of inflation from current level of 1% – and decline in the unemployment rate from 6.7% to the Fed’s threshold of 6.5%, high yield bond investors may suffer from low returns. For the moment, high yield bonds look attractive unless there is a dramatic change in the investor risk appetite, which can happen soon or later. In the medium to long-term, the fundamentals are against high yield bonds. The investors could consider the high yield bonds as a part of a well-diversified portfolio.

Continue to Part 5

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