High Yield Bond ETF Outflow Signal A Shift

If Guggenheim Chief Investment Officer Scott Minerd is right, a summer lull is already beginning to set into markets, and demand for risky-type assets such as high-yield bonds is going to decline significantly in the months ahead.

There’s no question that from an ETF perspective, Minerd’s assessment seems to be spot on. After piling into high-yield bond funds such as the SPDR Barclays High Yield Bond (JNK | B-68) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG | B-64) in recent years, searching for yield in an era of ultra-low rates, investors have been flocking out of these funds since March. The pace of redemptions has been picking up in earnest this month, with $1 billion flowing out of each of these funds in the first three weeks of June.

Fed Rhetoric Driving Demand

The Federal Reserve’s suggestion in March—and reiterated last week—that despite its more dovish stance on the long-term outlook for the U.S. economy, it would still consider a rate hike in the fall most likely a catalyst for the recent outflows. Consensus is fueling expectations for a September uptick in rates.

In simple terms, higher rates make safer debt such as Treasurys more appealing, and the risk associated with owning junk bonds less so.  

“We are becoming vulnerable to some sort of summer risk-off trade,” Minerd said in his most recent market commentary on Monday. “While I remain generally positive on U.S. equities over the next two to three years, I think it is very likely that we are going to have some sort of a nasty market event during the course of the summer.”

“At this stage, it would be prudent to prepare for a risk-off period by the opportunistic liquidation of lower-quality high-yield and bank loans, which have appreciated in price this year, and selectively taking gains in stocks while increasing holdings in cash and Treasury securities, as a precaution in preparation of a potential looming summer dislocation,” he added.

‘Consistent Sellers’

That “opportunistic liquidation” has certainly been seen in recent weeks. On top of both HYG and JNK seeing net redemptions of more than a $1 billion each in the first three weeks of June, since March 1, net redemptions already amount to $3.37 billion for HYG and $1.4 billion for JNK.

That’s a major reversal from the massive inflows both funds saw in the first two months of the year—HYG saw net creations of $3.23 billion and JNK saw $1.85 billion in total in January and February, respectively.

As one Street One Financial trader put it today, there’ve been “consistent sellers” in high-yield corporates lately.

The selling has come despite positive performance. Year-to-date, both ETFs are up, as the chart below shows: 

Chart courtesy of StockCharts.com

HYG Vs. JNK

HYG and JNK are the market’s largest high-yield bond portfolios, with $14.1 billion and $10.5 billion in total assets, respectively. The funds aren’t all that different, except that HYG is a more comprehensive portfolio comprising more than 1,000 holdings. HYG also has a shorter weighted average maturity of 6.1 years due to lower exposure to bonds with 10-plus years to maturity.

JNK’s average weighted maturity is 6.4 years, because the fund has heavier allocation to the five to 10-year part of the yield curve, according to ETF.com data. To investors, that means HYG isn’t as sensitive to changes in long-term rates, but it also means JNK delivers higher yields.

JNK’s yield-to-maturity—the weighted average yield if all securities in the portfolio were held to maturity—is currently 6.3 percent, relative to HYG’s 5.7 percent.