For the first time since the unprecedented exodus that accompanied the onset of the pandemic, investment grade credit funds suffered a sizable outflow.
Admittedly, “sizable” is a subjective term, but note that since the week of April 8, 2020, the largest outflow from high-grade funds was $1.58 billion in November. Other than that, outflows have been few, far between and minuscule.
Last week, though, investors yanked more than $2.5 billion from investment grade credit funds on Lipper’s data (figure below).
It was just the third outflow of 2021. It looks considerably more notable if you trim the y-axis to hide a portion of the anomalous outflows seen in and around the initial COVID panic, but I prefer to keep those “as is” — they’re a reminder of just how bad things really were and why the Fed decided to step in and backstop the corporate bond market. In hindsight, it’s easy enough to chastise policymakers for “ignoring moral hazard.” But recall that investment grade credit funds bled nearly $110 billion in just five weeks.
In any case, last week’s outflow came on the heels of significant volatility across markets as investors fretted over Evergrande contagion and the latest debt ceiling drama in D.C. Over the preceding three weeks, long-end US yields moved up sharply, a problem for IG given high duration.
High-grade returns were negative in September, as interest-rate risk came calling. Supply was robust, though, that’s for sure. The usual post-Labor Day binge was particularly outlandish this year. For the full month, issuance was more than $158 billion (figure below).
That was just short of the all-time September record set last year.
“In addition to the longer-term factors driving our bearish medium term view (primarily higher Treasury rates, inflation jitters, and the end of reserve injections into the financial system), the debt ceiling now becomes a factor that may weigh on spreads in the coming weeks,” BMO’s Daniel Krieter and Daniel Belton said Thursday. “The upward pressure naturally falls as the risk is no longer acute, but given how narrow credit spreads are, the environment has to be nearly perfect for further tightening,” they added, noting that “the lingering nature of the short-term debt ceiling resolution works against that scenario.”
Meanwhile, in high yield, Lipper’s data showed a $294 million outflow last week. The combined weekly outflow was the largest since November (figure below).
The good news for junk is that duration isn’t as problematic. The bad news is just that it’s highly susceptible to risk-off moves.
As for IG, don’t worry too much. As Bloomberg noted, “the highest-rated borrowers are still selling new debt in the primary markets without hiccups.” An offering from Pepsi this week was three times covered despite the macro tumult.
Hmm, institutions getting liquid in preparation for the tamper? If so, this would be the beginning of a trend. Will be interesting to see if this continues.
I can’t help but toss my Mar 2020 memories, this post, and the Albert Edwards post together in the blender. It does not come out Jimmy Buffet.
Recall that IG outflows of $110B in 5 weeks was the best case. In the mortgage space, my memories were of funds basically ejecting their portfolios, tossing out the prospectus, rewriting their investment objectives in a week around “agency-backed”, and starting from scratch with whatever desperate cash they could raise. Sure Covid was novel. But will the imminent reality of a protracted and globally tightening environment be any less alien than Covid to managers who’ve never seen it?
At any rate, if some confluence of factors manages to slow the earnings music, then each of these party goers will react. Resilient IG will gracefully turn and sashay toward the exits. But HY can’t dance; the lead boots of refi risk and credit quality will leave these dates quickly abandoned. And equity – well, it was really just rented for the party, wasn’t it?