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Trading  | November 17, 2017

Following this month’s drop in junk bond prices and the 40 bps spread widening in high yield last week – the largest since November 2016 – Bank of America has come up with an apt title for its weekly fund flow report: “Nightmare on Bond Street”…

… and with good reason: last week, US junk bond funds and ETFs reported a $4.43bn outflow this past week – the third largest outflow on record and the largest since August 2014. This follows a smaller $0.94Bn outflow the prior week. Non-US HY contributed an additional $2.3bn worth of redemptions, bringing the global junk outflow figure to -$6.7bn, also the 3rd largest ever.

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The near record outflows accompanied the second most aggressive round of selling in the US junk bond market in 2017. The weakness in performance only trails a sell-off that occurred in March, when spreads widened by 61 points in less than three weeks according to FT.

“It was very much a flows driven sell-off last week and in the beginning of this week,” said Tim Schwarz, a credit analyst with Investec Asset Management. “We saw a lot of . . . pockets of illiquidity.”

According to EPFR, roughly half of the US HY withdrawals came last Friday, when more than $2bn left the space in one day. Since then, the outflows have been slowly declining each day, from $585mn on Monday to $494mn yesterday. Somewhat surprisingly, large outflows such as the most recent bout are not correlated with subsequently weak performance. In fact, out of the 15 largest-ever daily high yield outflows recorded, next 3 month returns have been positive 10 times, with an average annualized return of 7.2%. According to BofA, this is likely because most of the spread widening occurs just before the flood of withdrawals, providing an opportunity to capture excess returns should the selloff prove to be temporary. Indeed, as BofA’s credit strategist note, given Thurdsday’s strong secondary performance, “we think such is likely to be the case in last week’s episode as investors have once again embraced a buy-the-dip mentality.

In contrast, EPFR also reports that flows for other fixed income asset classes were relatively stable. However, the large outflows from high yield and loans resulted in a net $1.32bn outflow from all bond funds and ETFs, after a $2.27bn inflow in the prior week.

Inflows to high grade were little changed at $3.31bn, down from $3.41bn a week earlier. Inflows to short-term fixed income increased (to $0.65bn from $0.27bn) while inflows outside of short-term declined (to $2.66bn from $3.15bn). Inflows were higher for high grade funds (to $1.83bn from $1.52bn), but lower for ETFs (to $1.48bn from $1.89bn). Inflows to global EM bonds weakened to $2.66bn from $3.15bn, mostly driven by local currency funds / ETFs. Inflows to munis instead improved to $0.34bn from $0.28bn. Finally, inflows to money markets were close to flat at $0.02bn, down from a $7.58bn inflow in the prior week.

Speaking to the FT, Robert Cusack, a PM at WhaleRock Point Partners, said that the recent high-yield sell-off could be short lived, likening it to the brief but rapid move higher in credit premiums earlier this year. But Cusack added that he is still looking to reduce exposure to the asset class.

“It’s a topic each week in our investment committee meetings and we have been discussing the risk reward in high yield now,” he said. “Our next move is to reduce our exposure in high yield.”

Meanwhile, there were no problems in equity land: flows to stocks improved to a $3.2 billion inflow, which however once again masked an ongoing divergence, as $9.9bn of this amount went to ETFs. Active, i.e., human managers, saw another outflow, this time for $6.7 billion as the non-ETF financial sector continues to die a slow, painful death.


18 MONTHS OR MORE OF UNPRECEDENTED OPPORTUNITY

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