High-yield ETFs ramp up market volatility
May 25 (IFR) - The impact of high-yield ETFs on volatility has been brought sharply into focus after the two largest weeks of ETF outflows ever measured led to dramatic drops in the market.
The large outflows piled on to negative sentiment at a time when markets were already jittery due to troubles in the eurozone and the overall macro environment.
While the outflows hit the high-yield market generally, they also had a significant impact on specific bond issues that are widely held by exchange-traded funds (ETFs).
"The real go-go bonds are generally owned by ETFs in size," said John Fekete, portfolio manager of Crescent Capital.
"When ETFs need to generate liquidity, that's what they sell first. And if you are in those, you'll get steamrolled," said Fekete. "I try to avoid those specific issues held by ETFs when possible."
High-yield ETFs saw an outflow of $917.4m in the week ending May 16 and another $895m in outflow the following week.
They were the two biggest weekly outflows ever according to Lipper, which has been tracking high-yield ETFs since their inception, and had a major impact on key issues.
"I think it spooked people, and they followed suit from the headline withdrawal," said Jeff Tjornehoj, a senior research analyst at Lipper.
Earlier in the year, when the high-yield market was strong, ETFs saw significant inflows, which had the effect of driving these most liquid issues higher to the benefit of all investors in the credits.
But in the downturn, these issues are leading the fall.
First Data's 12.625% senior unsecured notes due 2021, which have been among the top holdings in the two top ETFs, have fallen six to seven points this month to around 94.75.
However First Data's 9.875% senior unsecured notes due 2015 -- in the same place in the capital structure, with the same rating, but not included in the ETFs -- have dropped only two to three points, to around 99.
"Investors really need to be cognizant of what's in the ETFs," Fekete said. "It's not just the issuers they hold, it's the specific issues they hold that you need to pay attention to."
The massive ETF outflow in the week ending May 16 was mainly the result of a large individual redemption from the SPDR Barclays Capital High Yield Bond ETF (JNK), which is managed by State Street.
A single investor withdrew a reported US$788m on May 8.
Analysts at Barclays wrote last week that they did not see the individual's redemption as a signal of bearish sentiment, owing to the fact that the investor remained in the high-yield market.
However, they noted, the move added to "the already-strong evidence that cash market liquidity remains challenged, as less traditional avenues for accessing liquidity in the cash market have become more attractive."
By their nature, high-yield ETFs include indexed names in their portfolio, which are generally the largest, most liquid names in the high-yield universe.
The JNK, for instance, corresponds to the Barclays Capital High Yield Very Liquid Index, and includes bonds with US$600m or more in face value.
So far this year, high-yield ETFs have underperformed their indices. The iShares iBoxx $ High Yield Corporate Bond Fund (HYG) has returned 1.15% year to date. The HYG follows the iBoxx $ Liquid High Yield index, which has returned 3.36% year to date.
The JNK has returned 2.32% as of Wednesday, which compares to 3.83% for the index it follows. The broader Barclays US Corporate High Yield has returned 4.90%.
That broader Barclays index shows the average yield-to-worst moving to 7.84% on Thursday, nearly 100bp wider than its recent low of 6.96% on May 3 before the latest outflows began.
The average option-adjusted spread was seen at 656bp on Wednesday from 572bp on May 3.
As a result, a number of new deals in the primary market have had to price well wide of talk, or have simply been postponed as opportunistic issuers, not willing to pay the market clearing price, step back to the sidelines.
Despite the recent outflows, Lipper currently reports a total of US$26.7bn in ETF assets -- down from the early May high of US$29bn but still a meaningful increase from the US$16.9bn seen a year ago, as retail and institutional investors have piled into the ETFs in the hunt for yield.
Year to date, investors have contributed US$5.586bn to ETFs. Excluding ETFs, traditional high-yield mutual funds report US$121.8bn in total assets. They saw a US$1.56bn outflow for the week ending Wednesday.
Overall, the US$2.46bn that flowed out of both mutual funds and ETFs this week marks the third largest outflow on record. And in the current environment, that trend could continue.
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