Why bond investors are focusing on credit ratings and quality

Phalguni Soni

Must-know: Corporate bond trends in the week ending August 15 (Part 1 of 9)

Corporate bond market trends in the week ending August 15

High-yield bond (HYG) funds have seen some wild swings lately. A record of $7.1 billion was withdrawn in the week ending August 8. In the week ending August 15, some of those flows reversed. Net flows into junk bond (JNK) funds were positive because overseas risk perceptions receded. Investors also appeared to have oversold the asset class the previous week. They looked to get back into the market at lower valuations.

In contrast, investors continued to enter investment-grade bond funds. The funds recorded net inflows for the ninth consecutive week. U.S. investment-grade debt is considered a safe-haven for assets during international turmoil.

 

In this series, you’ll read about the factors that affected corporate bond markets last week. We’ll also analyze the factors that will likely influence exchange-traded fund (or ETF) returns and investor flows into bond mutual funds.

Primary market activity in U.S. corporate bonds

Due to the seasonal slowdown in July and August, investment-grade bond (LQD) issuance dropped by 33% to $16.7 billion last week. Major issuers included UBS, Motorola, and Expedia. Expedia is part of the NASDAQ-100 Index (QQQ). Burlington Northern Santa Fe, a railroad company, was also one of the major issuers in the week. The firm is wholly-owned by Warren Buffet’s Berkshire Hathaway (BRK-B).

Leveraged loan issuance also increased. It spiked 141% week-over-week to $21.2 billion. It spiked due to several mega-deals that came to market (refer to Part 8).

In contrast, high-debt issuance volumes dropped 55% to just $975 million. Yields on lower-rated debt increased sharply since late July. The yields increased because of Argentina’s debt default and signs of banking stress in Europe. This caused a lot of high-yield and leveraged loan issues to be postponed, trimmed down, or pulled out altogether.

What this means for bond investors

For most of 2014, junk bond yields were trending downwards in almost a straight-line fashion. In June, they reached a historically low level . Going forward, investors could see increased volatility in high-yield debt—in terms of yields and investor flows. Short-term profit-taking could be a key factor that affects flows and makes returns more volatile. Volatility in the asset class will likely increase as we move closer to 2015. The Fed is expected to end its rate tightening cycle sometime after 1Q15.

Increasing investor preference for leveraged loan issues compared to high-yield debt, is another trend that could be seen soon. Since leveraged loans are issued on a floating rate basis, investors get the benefit of rising rates. They’re protected from interest rate volatility.

In the next part of the series, you’ll learn more about high-grade bond issues.

Continue to Part 2

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