High-yield fervor fades

Dec 2, 2012 @ 12:01 am

By Jeff Benjamin

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

Two consecutive one-week periods of net outflows totaling $2.5 billion through Nov. 21 stand out in a category that has had a record $69.5 billion in net inflows since the start of the year.

The year-to-date inflows 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.

The recent pattern of outflows could represent a combination of factors, including uncertainty surrounding the looming fiscal cliff, year-end portfolio management or tax-planning strategies, he said.

But it also could represent a turning point at which investors are starting to see less value in the category as a result of the pace of inflows, Mr. Brandt said.


“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.”

High-yield-bond funds as a category have gained 12.3% so far this year, compared with 2.8% in 2011, according to Morningstar Inc.

The broader Barclays Capital U.S. Aggregate Bond Index is up 4.2% this year and gained 7.8% last year.

Gershon Distenfeld, director of high yield at AllianceBernstein LP, dismissed the idea that investors could start leaving high-yield bonds for more-attractive opportunities, mostly because they aren't there.

“Cash is paying you nothing, and equities are very volatile and uncertain,” he said.

Mr. Brandt thinks investors might be ready to start looking beyond high-yield bonds for the next area of value in fixed income.

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

The rationale behind allocating to emerging markets is tied to “increased political noise in some of those areas,” Mr. Brandt said.

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

“If you're searching for value, you might think that all the value has already been squeezed out of high-yield bonds,” Mr. Brandt said.

Along those lines, Intrepid Capital Management Inc. portfolio manager Jason Lazarus acknowledged that the flood of money into the high-yield-bond category could be cause for concern.

Mr. Lazarus, who has a 40% allocation to cash in his high-yield-oriented Intrepid Fund (ICMYX), cited a record-low yield of 6.2% in October on the BofA Merrill Lynch US High Yield Master II benchmark. The yield has since climbed slightly, to 6.5%.

“There are always defaults in the high-yield space, and in periods of distress, you could see 10% of all outstanding bonds default,” Mr. Lazarus said.


As both investors and portfolio managers express new signs of caution related to high-yield bonds, due diligence becomes even more important, according to Todd Rosenbluth, analyst at S&P Capital IQ.

“Since the election, and with the focus on the fiscal cliff issues becoming more prevalent, we've seen people reduce their risk profile,” he said.

Even investors comfortable with their risk levels should take a closer look at the allocations to high-yield-bond funds, Mr. Rosenbluth said.

“The higher the yield you're seeing, the further out on the risk spectrum the fund is invested,” he said.

Essentially, as money has poured into the sector, it has driven down yields, thus forcing portfolio managers to take on more risk just to maintain the same yield levels.

Mr. Rosenbluth recommends keeping an eye on a fund's published 30-day yields, which are posted monthly on fund company websites and by a number of third-party research firms, such as Morningstar and Standard & Poor's.

High-yield-bond funds are averaging yields of about 5%, he said.

“It comes down to two things,” Mr. Rosenbluth said. “Has your risk tolerance changed, and how risky is your high-yield-bond fund?”

jbenjamin@investmentnews.com Twitter: @jeff_benjamin


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