June 28 (IFR) - Investors are dumping US investment-grade and junk bonds at a frantic pace, and the sell-off could intensify next week when the full extent of recent losses becomes clear.
Quarter-end mutual fund reports will be arriving full of grim news for jittery investors who have seen the bond markets routed of late on fears the Fed is preparing to pull the plug on the asset purchases that have kept bonds on a roll for months.
And the ensuing sticker shock could end up deepening the belief that the great bond rally has run its course - and speeding up the race for the exit doors.
“The big question now is what will be the knock-on effect on investment sentiment, once the quarter-end numbers show losses in underlying portfolios due to the sudden spike in Treasury yields,” said Leo Civitillo, global co-head of fixed income capital markets at Morgan Stanley.
“No one has a clear answer to that question at the moment.”
One thing that is clear is that investors are increasingly convinced that bonds are not the right play at the moment.
According to data from Lipper, a Thomson Reuters company, US$2.15 billion was pulled out of US corporate investment-grade bond funds in June - the first month of net outflow in the sector since August 2011.
The flight from junk bond funds was even starker, with a net outflow in June of US$11.375 billion - the biggest ever outflow in a month since Lipper began tracking fund flows in 1992.
And many believe the scope of the sell-off is even worse than those figures indicate.
“These numbers are hiding the true magnitude of outflows,” Hans Mikkelsen, credit strategist at Bank of America Merrill Lynch, wrote this week.
“This is partly because less than half of mutual funds and ETFs report daily or weekly fund flows.”
Total return on high-grade corporate bonds has been walloped since May 22, when Federal Reserve Chairman Ben Bernanke publicly suggested scaling back the Fed’s bond-buying stimulus.
As of Thursday’s close, the Barclays investment-grade corporate bond index was showing a 3.81% loss of total return for the year.
Return was a positive 0.72% on the day before Bernanke’s comments - meaning there has been a staggering 450 basis points (bp) of loss in little more than a month.
High-yield total returns have plunged a similar amount, going from a positive 5.39% to 1.16% over the same span of time
That is largely due to the 10-year Treasury yield having exploded 105bp from early May lows of 1.618% to a high this week of 2.667%.
As a bond’s yields rise in tandem with Treasury yields, its prices fall. But while the drop in total returns is hurting many investors, others with deeper pockets are seizing the opportunity to buy.
Many asset managers whose pension fund clients are willing to take longer-term bets have been preparing for months for rates to rise - and are ready to make the most of it.
Because the same funds that are seeing investors rush out the exits away from bonds are having to sell bond holdings in order to have the cash to pay for those redemptions.
It’s a kind of vicious circle that lets those with the available cash - and the appetite for the risk - to seize the moment.
“These are the types of markets that we thrive in,” said Frank Reda, director of trading at Taplin, Canida and Habacht, an asset management division of Bank of Montreal.
“We keep a decent amount of dry powder for the times when we can provide a rare source of liquidity to people who are desperately in need of it.”
Even so, such buyers are relatively few and far between - and traders say none of them are the usual broker dealers on Wall Street, which don’t want more risky assets on their books in the current rising-rates environment.
“The Street is not taking down bonds at all,” said one director of trading at a firm managing corporate pension fund money. “Dealers don’t want risk, period - long or short.”
Instead, pension funds and insurance companies are taking up the slack, lured by yields that are only now starting to rebound from what had been months of near-record lows.
“Investors like insurance companies will see these higher yields and start to actively buy,” said the head of fixed income investment at one of the largest US asset management firms.
“They haven’t been able to hit their yield bogies in years.”
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