High Yield Investors Go With The Fund Flows

The disaster that was 2008 ended with the promise of a big comeback, at least in the arena of high yield bond funds. The final weeks of last year saw more inflows than outflows for the asset class, signaling renewed interest likely to carry into 2009.

High yield funds took in $1.7 billion in the last five weeks of 2008, and inflows beat outflows in seven of the last nine weeks of the year, according to EPFR Global. Bond funds were still losers for the year, with a total of $8.8 billion in outflows, but the move into positive territory in the fourth quarter indicates an increased interest in the asset class on the part of investors.

"Clearly the market is getting better," said Robert Adler, president of AMG Data Services. "The outflows appear to be abating or decelerating." He pointed out that $473 million in inflows were reported for the week ending Dec. 30, and $300 million in inflows were reported for the week ending Dec. 23, the largest the sector has experienced since May. Consecutive weeks of inflows beating outflows in high yield had not occurred since May either, Adler added. Overall performance of high yield funds was positive by an aggregate average of 5% for the last two weeks of 2008, he said, and investors responded in kind.

Portfolio managers began noticing inflows into funds as spreads hit historic highs and analysts started to project better returns for high yield bonds than equities. "We got to a spread level in the forth quarter that was clearly at record highs and dollar prices that were at record lows," said Kenneth Monaghan, a portfolio manager with Rogge Global Partners. "That's attracted new investors or people who are cycling back into the area after cycling out of credit."

And fund investors are not simply sequacious followers of yield, but are also responding to the federal government's actions to stabilize the macro-economic environment. "You had some asset allocators move back in once the massive policy response by the federal government that alleviated some of the systemic risk in the market had gone through," said John Fruit, a portfolio manager with FAF Advisors. A growing sentiment began to take hold in mid-December that the high yield asset class had reached a compelling risk-reward ratio, he said. This is particularly the case when compared with other asset classes, and there has been a recognition that the massive deleveraging of the market has run its course, at least for the time being, Fruit added.

AMG reports that the asset base for high yield bond funds now stands at approximately $85 million, down from $125 million last July. But the switch into positive territory in the fourth quarter indicates an increased interest in the asset class.

EPFR's report points out that while high yield bonds are now priced to reflect a 20% or greater default rate, higher quality companies being downgraded into the asset class, lower interest rates and fuel costs, and investor hunger for yield are bringing new investors into high yield.

"It's always a combination of traditional investors getting back into the market and non-traditional or high-grade investors rotating away from Treasurys, and probably the equity constituencies taking advantage of trade-up in the capital structure," said Fruit. Some of these investors have been pushed to the corporate bond market because yields on U.S. Treasurys are incredibly low. This has moved some investors back to credit, and also brought in institutions that otherwise might have retreated to Treasurys from the equity market.

"There are people looking at the space who haven't looked at it in the past in terms of institutional investors," said Monaghan. He said that the new investors include pension funds, foundations and endowments, both domestic and international. "There are people that are looking at this who are more opportunistic. We have clients who invest over a cycle... There are a number of equity investors in the space, and we get questions from people we know in the equity arena."

The fact that there are not any new issues on the calendar and dealers have been very lean on inventory has helped push demand, Monaghan pointed out. "When buyers come in and there is nothing to buy or very little to buy, the only way to purchase something is raise your bid level," he said.

Adler says that the quest for yield is going to contribute to a continued trend of inflows beating outflows this year. "Clearly investors are reaching for yield," he said. "That appears to be the issue right now, either on income alone or in combo with the principal opportunities in high yield and bank loans... The market has been positive."

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