Some in the investing public have tried to explain the recent sell-off in high yield with charts similar to those below. What they’re trying to portray is that the recent growth in fixed income mutual fund assets has exploded and could potentially overwhelm the dealers’ balance sheets and thus their ability to provide liquidity. A lack of liquidity can be the enemy of investors, so the worry is that should fund flows quickly turn negative bond, prices will need to drop dramatically to entice new buyers and clear the market.
Some of the more alarmist parts of the market have even gone on to say that this “situation” means that mutual funds need redemption or fees gates to help stem some sort of massive outflow. Scary stuff. Or is it?
We question whether these charts represent an actual increase a systemic risk that requires regulatory mitigation (something to be avoided) an opportunity for investors (something to be potentially embraced). The truth is that it’s probably both, but we’d argue more in favor of the recent high yield sell-off probably representing an opportunity.
First, consider the long-term trend that we’re seeing around the world – a need for yield and income. An aging population is looking to fund their impending retirement, and fixed income, particularly high yield, is and will be an attractive risk-adjusted way of meeting that need. Seen in this light, warnings of an imminent collapse in high yield seem a bit short-sighted.
Also understand that the sell-off in July might be more concerning if we hadn’t already recovered from something similar just over a year ago. Consider this; through the most recent sell-off, high yield funds have seen US$14 billion in redemptions and yields are currently at 6%. Yet in 2013, from May to July…what markets cutely nicknamed the “taper tantrum”… high yield outflows were $15 billion and yields rose to almost 7%. Markets recovered from that tantrum nicely, and given that high yield fundamentals are solid, will likely recover from this sell-off.
Fundamentals are the key in high yield right now…and they’re still positive. Defaults are expected to remain low, and earnings have been good. And, unlike in 2013, the sell-off has been contained to just high yield assets. All this makes the current situation feel more like a technical widening and not a fundamental reason to panic. That isn’t to say that we won’t see more volatility or more spread widening; both are probably out there. But for investors complaining that there aren’t any good opportunities in fixed income, high yield may be their best opportunity.
As to the need for regulation, I look back at that long-term trend toward income-producing assets. The growth in fixed income fund AUM likely represents a long-term and permanent increase in demand for income. If that’s the case, the volatility that we have experienced doesn’t portend a risk that needs to be regulated, but rather an opportunity to be captured.
The information in this article has been derived from sources believed to be accurate as of August 2014. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do not independently verify or guarantee its accuracy or validity.
The information in this article contains general information only on investment matters and should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The general information it contains does not take account of any investor’s investment objectives, particular needs or financial situation, nor should it be relied upon in any way as a forecast or guarantee of future events regarding a particular investment or the markets in general. All expressions of opinion and predictions in this document are subject to change without notice.
Subject to any contrary provisions of applicable law, no company in the Principal Financial Group nor any of their employees or directors gives any warranty of reliability or accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions in this article. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security.
Links contained in some blog posts may take you to third-party sites and Principal Global Investors makes no guarantees to the accuracy of the information provided.
Carefully consider a fund’s objectives, risks, charges, and expenses. Contact your financial professional or visit principalfunds.com for a prospectus, or summary prospectus if available, containing this and other information. Please read it carefully before investing.
Fixed-income investments are subject to interest rate risk; as interest rates rise their value will decline.
Lower-rated securities are subject to additional credit and default risks. Investing involves risk, including possible loss of principal.
Past performance does not guarantee future results. Illustrations do not reflect the performance of any Principal product. Investors cannot invest directly in an index.
Principal Funds are distributed by Principal Funds Distributor, Inc.