NEW YORK (Reuters) - The junk bond rally may be over, but investors should not expect a sharp unraveling.
Low supply in new high-yield bond offerings has kept prices afloat despite persistent investor outflows. High-yield bond funds have had net outflows in 10 of 13 weekly periods this year, totaling roughly $18 billion, according to Lipper data, as fears of rising interest rates have driven investors to other markets.
After a decade of declining yields and worsening covenants, outflows in the junk market have returned some power to buyers.
“We’re being more selective on the new issuance side,” said William Smith, high yield credit portfolio manager at AllianceBernstein. “We don’t feel the need to buy the regular high-yield issuers that haven’t really tightened covenants or are still trying to price deals aggressively. We think that being disciplined and picking your spots is the prudent way to invest in this market.”
The spread over Treasury bonds - the premium investors demand to hold the risky debt - has widened and covenants improved slightly in February according to Moody’s. But the primary response from issuers has been to reduce supply in an effort to wait out the junk bond fund outflows.
“Opportunistic issuers are holding back because with rates on the rise, the bargaining power is not as lopsided in their favor as it was last year,” said Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors.
Issues of new high-yield corporate debt in March are currently at $24 billion, half the issuance in the same month last year, according to JPMorgan. New supply in the year to date is $68.3 billion, 25 percent below the same period last year.
“In the year-to-date, high-yield is only down 1-2 percent compared to 3-4 percent in investment-grade. A lot of that is due to the reduced supply,” said Michael Donoghue, president of Phoenix Investment Adviser.
In the last Wednesday-Wednesday period recorded by Lipper, junk bond funds posted their largest withdrawals in over a month as investors pulled $1.2 billion on fears of rising interest rates, according to Lipper data. The Federal Reserve raised interest rates last week by a quarter of a percentage point to a range of 1.50 to 1.75 percent.
That would typically dent prices. But due to the reduced supply, prices on the two biggest indexes, the iShares iBoxx High Yield Corporate Bond ETFand the SPDR Barclays Capital High Yield Bond ETF, fell just 0.09 percent and 0.05 percent, respectively, over the last period reported by Lipper.
Junk bond prices have been falling on the whole this year, primarily because of interest rate hikes. Rising interest rates drive up yields on government bonds, decreasing the spread over Treasuries. The yield on the 10-year Treasury bond has risen sharply year-to-date, up 13.3 percentage points, also boosted by a flight to safe-haven investments amid geopolitical volatility.
But as long as issuers are able to withhold new supply, prices are not expected to unravel dramatically in the near term.
(This version of the story refiles to correct spelling of firm name to Phoenix Investment Adviser, not Phoenix Investment Advisors, in paragraph 8)
Reporting by Kate Duguid; editing by Jennifer Ablan and Dan Grebler