ETF Investors Are Ditching Billions in Credit

U.S. corporate bond ETFs are suffering from near-historic outflows over the past few weeks.

For instance, over the past week, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) , SPDR Barclays High Yield Bond ETF (JNK) and iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) were among the most hated ETFs, experiencing outflows of $849 million, $1.1 billion and $868 million, respectively.

While ETF investors were exhibiting apprehension with regard to the corporate debt category, holders of the underlying securities remained more upbeat, with credit spreads trading at their tightest on record, reflecting ongoing investment demand for corporate credit and new issues, Bloomberg reports.

The divergence has baffled Wall Street observers, but some simply attribute the dichotomy in investment demand for ETFs and debt securities to so-called dumb money versus smart money.

“The tax package is probably giving institutional investors more confidence about the shape of corporate balance sheets,” Matt Maley, a strategist at trading firm Miller Tabak + Co, told Bloomberg. “Thus they might be making up for the selling that is coming from these products geared towards individuals, who are worried about the rise in government yields.”

U.S. corporate bond ETFs are moving toward their second consecutive month of outflows, the first such period of weakness in the past seven years. For instance, LQD experienced its single worst day of losses last week since 2016 while HYG is still in the midst of its biggest two-month outflows on record.

Over the past two months, LQD saw $1.968 billion in net outflows and HYG experienced $2.628 billion in redemptions.

"It looks like constituents - either maturity, credit or liquidity differences between the two markets - have played a role, but there does seem to be a general weakening of ETFs relative to the market," Thomas Tzitzouris, fixed-income research chief at Strategas Research Partners, told Bloomberg. "At a high level, we believe that high-yield is running into resistance."

Meanwhile, spreads in junk- and investment-grade bonds are hovering near their tightest since 2007 even after high-yield premiums rose slightly.

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