US high yield pays a high oil price
Outflows of $2 billion in one week; investors seek shorter duration.
High-yield bond market participants have long argued that the growth of short duration funds and ETFs has injected unwanted volatility into the asset class – as amply demonstrated this year by the divergent fortunes of US and European markets.
High-yield bond yields in the energy sector are all over the map right now. A lot depends on the extent to which these companies are hedged
Peter Toal, Barclays
Seven consecutive weeks of net outflows from European high-yield bond funds were broken in January and €1.9 billion flowed back in, according to JPMorgan. This surge followed the ECB’s announcement of QE on January 22, which triggered further inflows of $1.9 billion in February.
There were €1.04 billion inflows in the week of March 18 alone, €81 million of which went to ETFs and €19 million to short duration funds. It was the third consecutive week of €1 billion-plus inflows, something that has never happened in the European high-yield market before.
The US high-yield market tells a different story.
“The concerns about oil prices had put some pressure on high yield late last year and at the beginning of this year, but in January and February investors started to come back in anticipating a rebound,” says Matt Tucker, head of iShares fixed income strategy at BlackRock. “In addition there was not enough issuance in the high-yield market to meet demand, so a lot of investors turned to ETFs to get quick exposure.”
Concerns over the energy sector, however, have taken their toll. According to Lipper, in early March a record $1.96 billion was withdrawn from high-yield funds in just one week, and a further $1 billion was pulled out the following week.
The iShares iBoxx $ High Yield Corporate Bond ETF suffered outflows of around $162.1 million, a 1% decrease, in the week of March 23.
“We’re still $1.3 billion up on the year but we have gone from high demand to now a backing away,” Tucker tells Euromoney. The US market had nevertheless still seen a net inflow of $8.2 billion year to date by March 18, 33% of which went to ETFs.
Certainly some of the recent withdrawals from US funds came in anticipation of the Federal Reserve meeting on March 18. Despite Fed chair Janet Yellen’s removal of the word “patient” from her statement, she hinted that a rate hike would be more likely in the third or fourth quarter than the first half of this year.
outflows from US high-yield funds in one week in March
The more positive economic mood in the US has led investors back to short duration high-yield bond funds. By March 19 the SPDR Barclays Short Term High Yield Bond ETF, which has an average duration of around two years and a yield of more than 5%, had attracted $300 million month-to-date, while the SPDR Barclays High Yield Bond ETF, which has a four-year duration, had lost $690 million.
“What investors are saying is that fundamentals are stronger than the market is pricing in,” says Dave Mazza, head of research for SPDR ETFs and SSGA funds at State Street. “The market seems to be pricing in defaults of 4% this year, but we believe this number will be closer to 2.8%. The savvier investors are taking advantage of this dislocation between market sentiment and fundamentals by rotating into shorter duration investments.”
Peter Toal, global head of leveraged finance syndicate at Barclays in New York, says that investors have sought shorter durations since the financial crisis. “After the crisis there was a lot of demand for short duration bonds. Yields were low and the market was seen a little expensive and investors did not want to go too far out on the curve. We saw a lot of issuance begin to come in the five-year and three-year bucket and that has stayed,” he says.
The result is a steep curve – with some 100 basis points between a five-year and a 10-year. That spread differential over Treasuries is encouraging companies to keep issuing at the short end and allowing investors to rotate their durations.
While demand for US high-yield ETFs is expected to remain stable this year, the price of oil will continue to create volatility. Retail investors in particular are more sensitive to media coverage of energy prices. The high-yield debt market has the most exposure to energy of any asset class and has seen issuers challenged.
Iron ore producer Fortescue recently had to shelve a $2.5 billion loan it tried to bring to market, and when it returned with a bond deal it received a similar reception. That has also caused investors to second guess the asset class.
“High-yield bond yields in the energy sector are all over the map right now,” says Toal. “A lot depends on the extent to which these companies are hedged. Some are looking at their reserve-based loans that are about to undergo redetermination and find that liquidity has been cut in half. April and May will be interesting for those issuers with loans coming up for redetermination.”
The acute yield compression in Europe could, however, see investors reappraise their view on the US market. “There is not a lot of yield in European high yield, investment grade or government bonds so you are likely to see global investors coming into the US high-yield market which will give it some support,” Toal predicts.