Investors move out of junk to high-grade debt

Low-rated bond funds, ETFs seeing money leave

http://www.marketwatch.com/story/investors-move-out-of-junk-to-high-grade-bonds-2012-11-16?siteid=bigcharts&dist=bigcharts

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By Deborah Levine, MarketWatch

SAN FRANCISCO (MarketWatch) — Investors are shifting toward investment-grade bonds and out of high-yield bonds as the year comes to a close and as falling yields are weighing on the appeal of reaching toward the riskiest form of U.S. debt.

Mutual-fund flows into investment-grade totaled $1.16 billion in the past week, following the biggest weekly inflow in at least two months, according to Lipper data. Over that period, assets going into speculative-grade debt, also known as junk bonds, have been far smaller, and even negative in several weeks. 

Weekly high-grade inflows have totaled about $18.2 billion since early September, while junk bond funds have lost $527 million.

Besides uncertainty surrounding the U.S. election and fiscal policy, as well as Europe’s far-from-resolved debt crisis, the extra yield investors get for holding higher-risk debt has declined.

“Investors have been throttling down risk in the current environment, which is a reflection of the spreads coming in and not being as attractive as they were early in the year,” said Colin Lundgren, head of fixed income for Columbia Management, which manages about $170 billion in bonds. “We’re also facing obvious challenges and uncertainty around the fiscal cliff, so we’re seeing the trade of taking some chips off the table more generally.”

Similar to mutual funds, cash has migrated out of the biggest junk-bond exchange-traded funds — SPDR Barclays High Yield Bond JNK +0.15% and iShares iBoxx High Yield Corporate Bond HYG +0.19% —according to ETF Trends.

Corporate bonds of all maturities returned 10.1% in the year through Nov. 6 — Election Day — according to an index compiled by Bank of America Merrill Lynch. They’re edged up to rise 10.4% year-to-date since then.

High-yield bonds returned 13.4% in 2012 through last Tuesday. They’ve pared that to 12.2% through Thursday.

Looking ahead, Lundgren says its unlikely to again see total returns much higher than the yield on a bond, because there isn’t as much room for price appreciation or a further narrowing of the yield spread over Treasury rates.

Corporate debt yields near record lows

Investment-grade bonds yield about 2.64%, near the lowest ever for the Barclays U.S. investment-grade index, set last week. That’s down from 3.76% a year ago.

High-yield bonds yield about 6.67%, according to Barclays U.S. high-yield index. That’s up from the all-time low of 6.14% set in September, but down from 8.57% a year ago. Read: Treasury yields hit lowest since August on cliff worries. 

“The year 2013 may be a year of investing in fixed income less dangerously and managing expectations” to be around the coupon yield or a little below that, Lundgren said.

The fundamentals for companies are still attractive but the valuations aren’t as compelling, he said. And demand from investors should still be fair but not a continuation of the “insatiable appetite” seen in the better part of this year.

RBS Securities’ strategists also said they are changing their recommendation to clients to be moderately overweight investment-grade versus high yield because of waning flowing into the sector and predicted higher volatility (that tends to make junk bonds behave like stocks). Also , more and more, issuers are selling types of debt that are less favorable to bondholders.

On the other hand, some think the uncertainty is going to depress yields across all sectors, but there’s still more value in high-yield bonds.

While the yield on junk bonds, around 6.67%, are indeed historically low, so are the risks an investor is compensated for, said Peter Palfrey, co-manager of Loomis Sayles’ Core Plus Bond Fund NERYX -0.07% .

“Default risk is running extraordinarily low and corporate balance sheets have never been better,” he said. “U.S. and global growth are going to be soft, but stay positive,” which will be enough for companies to pay their debts.

“Support for risk markets will continue so investors should be getting as much yield as they can,” he said.

Deborah Levine is a MarketWatch reporter, based in San Francisco.