Junk bonds have outperformed all major asset classes over the past three years. But junk bond funds are now under selling pressure. Investors have been removing money from junk bond funds at record levels recently. Levels of redemptions were at their fourth largest levels on record last week as net outflows from junk bond mutual funds and exchange traded funds amounted to $2.46 billion.
UBS reportedly said that outflows from junk bond exchange traded funds would have been even bigger were it not for short covering by traders who had bet against those ETFs. In addition, professional investors are bearish on junk bond funds. Concerns about Europe, in particular, are eroding the sentiment that drove a rally in junk bonds earlier in the year.
Individual investors looking for better yields who helped fuel the run-up are in danger if selling continues. If demand continues to erode, so will liquidity. If selling increases and liquidity dries up, fund managers will have to sell their best assets at fire sale prices to cover redemptions demands. Investors and their advisors would be well-advised to reconsider their allocation to high-yield investments.
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