A wall of money has flooded into high yield corporate bond funds this year, as investors chase attractive yields buoyed by hopes that default rates will remain near their historic lows.
High yield bond funds saw net inflows of $30.7bn in the first quarter of 2012, according to data from EPFR Global, within a whisker of the record full-year tally of $31.8bn in 2009.
The buying spree has been propelled by the “risk-on” trade, which has encouraged some investors to embrace higher risk assets, as well as signs that yields for high quality government bonds are starting to rise from their extreme lows, hurting risk-averse investors.
It has caught some by surprise, with Goldman Sachs recommending a short position in European high yield as one of its top six trades for 2012.
Todd Youngberg, global investment director of fixed income at Aviva Investors, whose Global High Yield Bond Fund has taken $800m since October, pushing it above $1bn, said: “Default rates are very low and they are expected to stay very low. If you can get a yield of 7 per cent with a low default risk and the possibility of a little spread tightening, it’s quite attractive.”
Alexandre Caminade, chief investment officer for European credit at Allianz Global Investors, saw signs that insurance companies were switching from equities to high yield bonds to comply with the European Union’s forthcoming Solvency II directive. “We are talking about big numbers: billions. Insurance companies need to diversify. That could be a very big support for high yield bonds,” said Mr Caminade.
The inflows have pushed yields a little lower, to 7.2 per cent in the US and 8.4 per cent in Europe, but spreads over investment-grade government bonds remain above their long-term average of 550 basis points.
Moreover, the trailing 12-month default rate is just 2 per cent, according to Moody’s, well below the historic average of 4.5 per cent.
“The pricing of high yield bonds reflects a risk of global recession. Spreads are still high despite extremely low levels for defaults,” said Hans Peterson, chief investment officer for private banking at SEB, who did not believe a recession was likely.
Mr Youngberg also saw little risk of default rates rising above 2.5-3 per cent. He said: “Corporates have record amounts of cash on their balance sheets and there is not a lot of refinancing needed.
“Profitability is good, free cash flow generation is high and balance sheet strength is good.”
Mr Caminade added: “If you pick up companies with good cash balances, stable margins and positive cash flow, your risk is low over the next one to two years. Even if the global picture is uncertain, companies are delivering decent results.”
John Keller, senior product engineer at State Street Global Advisors, said investors waiting for an “all-clear signal” before moving into high yield bonds risked missing a “rapidly diminishing” window of opportunity. “Higher yielding sectors represent approximately $4.4tn or only 23 per cent of the approximate $19tn of investable assets in the US fixed income markets,” said Mr Keller.
“Given the large size of the sovereign markets, any significant change in allocation by investors could have a significant impact, driving yields lower.
“The high yield market may prove volatile but, long term, it offers the best returns.”