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Vanguard Closes High-Yield Fund — ETF Alternatives

tlydon@globaltrend.com (Tom Lydon)

The seemingly insatiable demand for high-yield corporate debt has forced Vanguard to close a junk bond mutual fund after investors pumped $2 billion into the fund the past six months.

The firm is closing the $16.9 billion High-Yield Corporate Fund to most new accounts “in an effort to curtain strong cash inflows,” according to a press release Thursday.

“In this prolonged low-rate environment, we continue to see investors turn to high-yielding alternatives— including money market fund holders moving to bond funds, U.S. Treasury bond fund holders moving to high-yield corporate funds, and bond fund holders moving to dividend-paying stock funds. And we’ve cautioned investors accordingly about reaching for yield,” said Vanguard CEO Bill McNabb. “The flows into the High Yield Corporate Fund have been particularly acute.”

ETFs that invest in high-yield corporate bonds include SPDR Barclays Capital High Yield Bond ETF (JNK - News), iShares iBoxx High Yield Fund (HYG - News), PowerShares High Yield Corporate (PHB - News) and PIMCO 0-5 Year High Yield Corporate Bond (HYS - News). [Largest Junk Bond ETFs Offer 7% Yields]

Junk bond ETFs have been extremely popular this year. [ETF Spotlight: High-Yield Corporate Bonds]

In the first quarter, Fitch estimates total retail fund flows into high-yield bonds reached $15 billion, with at least 20% of the total resulting from new flows into junk bond ETFs.

“Fitch believes leveraged bond ETFs are improving liquidity and should broaden the high-yield investor base. However, the trend may also contribute to market volatility and potentially de-link some aspects of bond pricing from credit fundamentals,” the firm said.

A large trade in one junk-bond ETF, JNK, this month has attracted attention because an investor apparently used the fund to acquire a large chunk of bonds quietly away from the secondary market. [Will More Big Investors Use ETFs to Disguise Trades?]

“Expanded use of high-yield ETFs as a short-term trading platform will likely fuel more market volatility, particularly in periods of macro stress, when risk re-allocation could drive big swings in ETF flows. In periods of asset inflows such as the first quarter, this should support tighter spreads on new issues, particularly for large leveraged issuers whose bonds must be acquired by ETFs,” Fitch said.

“At the same time, forced selling could be exacerbated by hot money flows during periods when fundamentals are weakening and investors are pulling back from riskier asset classes,” it added. “This has the potential to reinforce liquidity-driven price moves in high-yield bonds that may have little or no relation to changes in credit fundamentals.”