Advisors searching for yield in the current continuous low-yield bond market may want to think twice before adding high-yield debt to portfolios. To say that the sector has been volatile would be an understatement, especially in the most popular high-yield ETF, the iShares iBoxx High Yield Corporate Bond ETF (HYG).
After a 12% rally from mid-February through the end of April, investors have withdrawn billions from high-yield ETFs — the bulk from HYG — and prices fell. HYG saw $3.6 billion in outflows during the six trading days that ended Friday, May 6 — a record decline and more than twice the previous record.
Some analysts attribute the outflows to a change in sentiment about high-yield bonds; others to sales of ETF shares in order to purchase the underlying securities. But whatever the reason, the high yield market has been falling after a strong rally earlier this year, and the outlook has turned bleak.
Jim Bianco, president of Chicago-based Bianco Research, subscribes to the change-in-sentiment analysis, based on a lack of data showing ETF outflows moving into the underlying bonds. He says money is leaving the high-yield market in large part because corporate earnings are weak and oil prices, which are once again falling, have a big impact on the high-yield market. Oil company debt accounts for about 17% of the high-yield bond market, says Bianco.
In addition, Bianco says high-yield ETFs have an “outsized influence” on the underlying cash market because turnover in high yield ETFs account for about 20% of the turnover in the underlying cash market. In other markets, ETF turnover is about 1% to 2% of the turnover in the cash market. It’s like the “tail wagging the dog,” says Bianco. “High-yield ETFs are driving the market, not the market driving the ETFs. That has always been a risk with high-yield ETFs,” says Bianco. “High-yield traders are the only ones that will react to flows in and out of ETFs.”
Michael Contopoulos, head of Bank of America Merrill Lynch’s High Yield and Relative Value Strategy, disagrees with Bianco about where outflows from high-yield ETFs are going but he’s equally bearish about the market and has been for over a year.
Contopoulos says outflows from high-yield ETFs are making their way into the underlying cash market but not showing up in data about the secondary market because ETF investors are simply exchanging shares for the underlying securities. He is bearish on high yield because “fundamentals are poor … revenues weak, earnings growth bad and leverage high,” noting also that more companies are reporting impairment charges to write off goodwill.