High-Yield Bond ETF Outflows Spike To Record

We have been monitoring the shifts in the high-yield bond market for a few weeks, noting that bond ETF and credit derivative markets are showing some serious (divergent from stocks) signs of risk-off. Whether this was driven by call-constraints limiting upside potential, a fundamental realization of a shifting macro background, or ad hoc idiosyncratic risk elevation due to releveragings and potential public-to-private transactions is unclear. What is clear is that this week saw the largest HY ETF outflow on record. Furthermore, HYG's shares outstanding have plunged over 11% in the last 90 days as ETF units are for the first time destroyed QoQ not created. The rotation appears to be up-in-quality and up-in-capital structure as loan funds saw inflows - but with stocks and credit linked inexorably via the balance sheet, the divergence cannot last forever (and never has). Until very recently this has not spilled over into the cash bond market, but the last few days have seen selling pressure picking up into this illiquid market.


US HY ETF outflows hit a record this week...


While risk-aversion is clearly high in credit, the repression of underlying rates has forced HY bond prices well above Par in many cases... leaving them largely call-constrained (or upside limited)

The risk-off flows from HY bonds appears to be an up-in-quality trend (IG inflows remain robust) but even more an up-in-capital-structure trade (another sign of concerned risk aversion) as US Loan funds see inflows surge...


HYG - the HY Bond ETF - saw shares outstanding destroyed at a record pace in the last 90 days - the first time ever a 90-day period has seen unit destruction not creation...


But until recently, the ETF unit destruction had not impacted the actual physical cash bond market - but as is clear now (the blue line) - selling is picking up.


The HY bond market is illiquid; it is not like a stock market. When sellers appear, prices can gap quickly and given the size and velocity of outflows, it is no wonder that high yield bond managers appear willing to pay up for protection of their overall books (as HY CDX spreads push notably wider than their fair-value).

The disconnect is extremely clear (between stocks and HY credit) but what is less obvious is the lower pane where we see the virtuous ETF premium to NAV switch to a discount - putting pressure on the underlying bonds...


The hope, of course, being that the macro protection will enable then to ride this short-term storm without being forced to sell... Let's hope that is the case, or first mover advantage is very much the order of the day for the over-stuffed world of HY fund managers.

In recent years, equity valuations have correlated extremely highly with low-rated credit - something has to give.

Source: BofAML and Bloomberg


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