February 8, 2013 6:33 pm

US junk bond funds see $1.2bn exodus

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Investors pulled $1.2bn from US junk bond funds in the week that ended Wednesday, abandoning one of the hottest areas of the credit markets in recent years for fear that interest rates could rise as the economy improves.

The money was redirected to funds that invest in loans, which pay a floating rate of interest and are being marketed as a potential way to offset the risk of rising benchmark interest rates.

US interest rates have been kept low for years by the Federal Reserve’s quantitative easing programme. But better economic data has raised the prospect of an end to the central bank’s programme, increasing the allure of loan funds.

“Bank loans are the next big trade,” said Michael Mullaney, a fund manager at Fiduciary Trust. If you are moving out of high-yield and into bank loans now, you are moving in right at the first inning of this game,” he pointed out.

The $1.2bn taken out of mutual funds and exchange traded funds that invest in junk bonds was the largest weekly outflow in eight months, according to EPFR Global. The net inflow into junk bond funds this year is now only $228m.

EPFR recorded a $1.3bn inflow into mutual funds and ETFs that buy floating rate bank loans during the week ending February 6.

Loan funds have become increasingly popular over the past year, but inflows have accelerated since the start of January, with more than $4bn added in the year to date.

The outflows from junk bond funds hit high yield bond prices hard this week, pushing average yields on the securities up by 40 basis points.

This took yields back above 6 per cent from a record low of 5.61 per cent less than two weeks ago, according to data from Barclays indices.

One single issuer, Ceasars Entertainment, saw its 10 per cent note due in 2018 fall two and a half points, according to Standard & Poor’s LCD data.

“Junk bonds went to the stratosphere as people hung to them as the last bastion of yield.

“Now, the bonds are coming back down to reality, which is: you can also lose money in high yield,” Mr Mullaney said.

Concern over the scale of the inflows into junk bonds prompted a Federal Reserve bank governor, Jeremy Stein, to warn on Thursday. “Overheating in the junk bond market might not be a major systemic concern in and of itself, but it might indicate that similar overheating forces were at play in other parts of credit markets, out of our range of vision.”

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