I spent what was probably an inordinate amount of time over the weekend talking about high yield and specifically, the veritable exodus from high yield funds that’s got everyone talking.
In case you missed it, here’s a summary of those outflows 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.
Citi had an amusing take:
Citi strikes again: "New York Fed President Dudley may think the recent market losses are small potatoes but high yield listed fund outflows are more like a thick steak." pic.twitter.com/tpRTbKBdib
— Walter White (@heisenbergrpt) February 19, 2018
Yes, “no small potatoes” when it comes to HY funds, which are bleeding to death. I mean, not really “to death” but the massive outflows do raise questions about whether continual pressure on the space could trigger a kind of self-feeding loop that, by the time it’s all said and done, ends up testing the underlying liquidity mismatch in HY ETFs like HYG and JNK.
More worrisome (on some level) is that ETF volumes as a percentage of cash bond trading are increasing as is their usage by HY mutual funds, which look to be holding the ETFs as something of a cash substitute or else as a flow management tool:
Some people would say what you see in those charts is a positive development. I’m more inclined to think the opposite, and not just because I’m a cynical asshole.
In any event, one person who thinks HY may be a “gasping canary” is Bloomberg’s Mark Cranfield. “Pinpointing the precise end of a high-yield credit cycle is more art than science, though history suggests that when the third year is reached, the end is much nearer than the beginning,” he writes.
If you look at spreads, you can see that after hitting 10.5-year lows late in January, things widened out materially earlier this month before order was restored, probably after investors decided to lean on the solid economic backdrop and benign default environment for the time being:
“The surge of bond fund redemptions in early February is a reminder of how quickly sentiment can change when investors try to rush through what is a notoriously narrow exit door,” Cranfield continues, adding that when you throw in algos, the situation can be more acute.
He also cautions that you may have to look beyond DM markets for the trigger event, noting that “the mountain of borrowing amassed by China’s companies has been cited as a key risk by some analysts [and] asset sales initiated by China’s HNA could be an example of what’s to come in the high-yield sector.”
Finally, he reminds you that this kind of thing can escalate quickly once the downgrades start. The bottom line: “The first canary may have already expired in this coal mine.”
On the bright side, remember that people were talking about high yield and canaries in November and we got through that ok.