The Barclays Global High Yield Index lost an unprecedented 3.7% of its value in dollar-terms in the first two weeks of December. The market correction, which was heavier as well as shorter-lived than comparable events in 2011, 2012 and 2013, prompted European investors to accelerate the high yield selling habit they had adopted in the latter half of last year.
Since July 2014, European investors have sold more than €25bn in high yield bonds. US, Global and European high yield bond funds have all been affected by the outflow streak, but in December most outflows came from the first two categories. This can possibly be explained by the relatively strong presence of oil-related companies on the US high yield market. Some of these companies are highly leveraged as they operate in an investment-intensive industry, and were hit hard by the unexpected plunge of the oil price last autumn.
Bearish fund selectors
The negative fund flows are matched by EIE’s sentiment records. Fund selectors planning to decrease exposure to high yield bonds have consistently outnumbered those who consider increasing allocation over 2014 on a Pan-European basis. In all but one country (Portugal*) sentiment has been net negative by a huge margin over the period.
Q€ stimulus for high yield?
However, the steep fall in high yield prices mean the asset class is no longer as expensive as it was, and this opens up new opportunities for investors. Moreover, the extremely low risk-free rates and the ECB’s launch of QE can work as a catalyst for risky assets such as high yield, says Dinant Wansink, an economist and asset allocation strategist for insurance company Delta Lloyd in Amsterdam.
“When risk-free rates are low, spreads start to behave in a proportionate rather than in an absolute way,” he says. “This means that they will come down faster than government bond yields. Another drop of the risk-free yield of 10 basis points could easily trigger a drop of 30 basis points of the riskier, higher-yielding product”, according to Wansink.
And indeed, since the trough of the market correction mid-December, the Barclays Global High Yield Index has edged roughly 2% higher again, and even 12.7% in euro terms! This a much higher gain than the mere 2.64% advance in euro terms of the BofA ML Euro Government Bond Index. But one should remain vigilant: high yield remains very volatile compared to higher-rated bonds (see graph above).
* If you’re interested to know why, our Iberian researcher is in Lisbon at the moment, gauging the local fund selector sentiment, so I might be able to tell you soon about the Portuguese love for high yield.