In High Yield: Exodus

Well, we’ve reached that listless holiday nadir when even Bloomberg has run out of shit to talk about and so you get the exceedingly rare “paid programming” on BBG TV. Right now, it’s a fun TIME Life add for a “Golden Oldies” album.

I’ve got a longer piece coming out elsewhere later today (hopefully) on this subject so I won’t get too deep in the weeds with it here, but in light of the post we ran here earlier on the extent to which, as Deutsche Bank puts it, “the next nexus of risk is the credit space,” I wanted to draw your attention to a pretty incredible chart from BofAML.

As noted in the piece linked above, outflows from corporate credit ETFs, and particularly from HY vehicles, have the potential to feed back into the source where the source is a VIX spike. You can read the excerpts yourself, but the gist of it is as follows according to Deutsche’s models:

• a 1 point rise in VIX is worth -0.6% to IG ETFs in aggregate, and -1.3% to the universe of HY funds and;
• a 1% m/m selloff in IG ETFs is consistent with a 1.9% decline in IG ETF AUM (currently about $130bn), meaning a 0.9% liquidation; for HY ETFS, a 1% sell-off equates to a 2.8% drop in ETF AUM (currently about $45bn), and therefore a liquidation worth 1.8% of AUM.

For HY, Deutsche goes to note that there’s probably a self-feeding loop built in. Here’s how they put it in the context of the current environment where, again according to their models, credit hasn’t yet “caught up” to the VIX spike: “Should credit sell-off to where the current level of volatility implies, liquidity would likely deteriorate anyway, and the added pressure from fund outflows would likely further exacerbate the spread widening.”

I think it’s entirely fair to suggest that in the event that were to happen, the spread widening (i.e. the high yield selloff) would become a directional driver of risk appetite and thereby feed back into the VIX. So, something like this maybe:

Throw in a further move higher in rates vol., and things would really get interesting.

Well anyway, getting back to the BofAML chart mentioned above, it’s worth noting that we have just witnessed nothing short of a historic outflow from HY. Consider this from BofAML:

US HY funds experienced a $6.3bn (-2.9%) net outflow last week, their 2nd largest of alltime behind only August 6, 2014’s -$6.75bn (-3.15%). In dollar amounts, the outflows were relatively evenly distributed between HY ETFs (-$2.75bn, -6.0%) and open-ended funds (-$3.58bn, -2.1%), although the former lost significantly more as a percentage of AUM. Non-US HY funds also recognized significant redemptions last week with a $4.56bn (-1.5%) outflow, bringing the global HY tally to $10.9bn. On a trailing 4 week basis, US HY has lost nearly $11bn due to redemptions, putting this episode in a league with only the 2010 EU debt crisis, the 2013 taper tantrum, and the 2014 Ukraine plane crash for the most severe outflows ever.

That is some “bigly” shit right there.

Of course high yield rallied with equities to close last week as the VIX fell so it looks like for now, people are willing to lean on the fundamentals (i.e. solid economic backdrop and a benign environment for defaults).

But I guess what I would note is that clearly, it is not necessary to see a deterioration in the fundamental backdrop to send people running for their lives from HY funds.

Take that for whatever it’s worth.