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How to play Fed rate risk with bonds

Senior Credit Analyst

Leveraged loans continuing to plow ahead (Part 3 of 3)

(Continued from Part 2: Must-read: Impact of re-investment risk on leveraged loans)

Fund flows show that given current market conditions, most investors prefer the safety of leveraged loans

What do flows mean? Fund flows reflect where and when investors are moving their cash to be invested. Comparing across asset class serves as a popularity contest to gauge where investors are gambling their chips. For example, last week, high yield bonds (HYG) saw inflows of $0.5 billion and corporate investment grade bonds (BND) saw inflows of $1.4 billion.

While you can’t compare values directly because different asset classes have different absolute sizes and may appeal to different investors, comparing the trends shows where the speculative money is moving. Out of the three asset classes, high yield bonds have the highest interest rate sensitivity and stand to lose the most if tapering starts.

  • The high yield bond market (JNK) has been flip-flopping between positive and negative flows as investors make up their minds on the actual risk of tapering in September.
  • The corporate bond market has sustained relatively stable inflows, though not as robust and consistent as those of leveraged loans.

Given the looming uncertainty about tapering in September, leveraged loans are best positioned to maintain a much lower volatility (risk) with relatively attractive yields. Once tapering actually starts, investors may start rotating part of their portfolios out of bonds and into domestic and international equities.

Browse this series on Market Realist