Some investors are beginning to move away from high-yield, speculative-grade, "junk" bonds and related exchange traded funds after an impressive four-year run. The outflows have been a relative trickle so far, but some investors are worried about how rising interest rates would impact all fixed-income funds, including high-yield corporate bond ETFs.
Since bottoming out in December 2008, junk bonds have returned 143%, with the widely followed Bank of America/Merrill Lynch High Yield Master II Index reaching a record high in January, according to the Economic Times. Yields on high-yield debt dipped to a record low of 5.84% in January - bond prices and yields have an inverse relationship.
With yields now back to 6%, Bonnie Baha, head of Global Developed Credit at DoubleLine, believes the market "feels like it's been priced to perfection."
Consequently, managers have been cutting their junk exposure. For instance, the Loomis Sayles Bond Fund reduced its high-yield bond exposure to 24% from 35% a year ago.
Looking ahead, money managers are wary of rampant inflation due to the Fed's loose monetary policies and the eventual rise in interest rates, which would negatively affect bond prices.
"The 'don't fight the Fed' mentality, which has been driving corporate bonds prices higher, will have to reconcile at some point with the macroeconomic reality that there's more risk in the world than the market is choosing to acknowledge," Baha said in the article. "We're coming into a period where credit selection matters a lot. Buying credit blindly - a la the ETF space - is a dangerous game."
In the ETF space, 13 high-yield bond funds tracked by Lipper saw almost $8 billion in new inflows over 2012, whereas investors have pulled $1 billion from the funds so far this year. The iShares iBoxx High Yield Corporate Bond Fund (HYG), which makes up almost half of the high-yield ETF segment, lost $905 million in four straight weeks of outflows. Still, HYG remains a large ETF with $15 billion in assets.
"The main thing to be concerned about now would be the interest rate risk," Martin Fridson, chief executive of research firm FridsonVision LLC, said in the article.
iShares iBoxx High Yield Corporate Bond Fund
Max Chen contributed to this article.
Full disclosure: Tom Lydon's clients own HYG.