High-yield bond fling might be over

Record inflows reverse course; economic uncertainty, tax planning could be why

Nov 27, 2012 @ 3:05 pm

By Jeff Benjamin

high-yield bonds, junk bonds
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Investors' infatuation with high-yield-bond funds might have finally run its course, and that could be a sign of an inflection point in income investing.

Two consecutive weeks of net outflows totaling $2.5 billion stands out in a category that has seen a record $69.5 billion in net inflows since the start of the year.

The inflows this year are more than double the previous full-year record of $31.8 billion in 2009. Last year, high-yield-bond funds had net inflows of just $8.3 billion.

“Two weeks is not enough swallows to make a summer, but it is an indicator,” said Cameron Brandt, director of research at EPFR Global, which tracks fund flows.

Mr. Brandt surmised that the recent outflows could represent a combination of factors, including uncertainty surrounding the looming fiscal cliff and year-end tax planning or portfolio management.

But he said it also could represent an inflection point at which investors are starting to see less value in the category as a result of the historic pace of inflows.

“When investors start to bail out of high yield, they tend to do it with a vengeance,” he said. “It has been a banner year for inflows, and what I see is certainly a degree of discomfort among investors with how fast the asset class has been bought.”

According to Morningstar Inc., high-yield-bond funds have gained 12.3% so far this year, compared with 2.8% in all of 2011.

The broader Barclays U.S. Aggregate Bond Index is up 4.2% this year after advancing 7.8% last year.

Gershon Distenfeld, director of high yield at AllianceBernstein LP, dismissed the idea that investors could start leaving the high-yield-bond category for more-attractive opportunities, mostly because there are not a lot of other opportunities.

“I have a hard time with the idea that there will be huge outflows, because what are investors' alternatives?” he said. “Cash is paying you nothing, and equities are very volatile and uncertain.”

From his perspective, Mr. Brandt believes that investors might be ready to start looking beyond high-yield bonds for the next area of value in the fixed-income space.

“I have been hearing a certain buzz lately that emerging-market bonds are the next high yield, especially the local-currency version,” he said.

The rationale behind an allocation to emerging markets, he added, is tied to “increased political noise in some of those areas.”

In essence, where some see political noise as increased risk, the savvy investors will see opportunity.

“There tends to be [an investment] reaction to the political noise,” he said. “If you're searching for value, you might think that all the value has already been squeezed out of high-yield bonds.”

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