High yield mutual funds and ETFs, which were popular among investors for years at a time of record-low interest rates, now appear to be losing steam. With the U.S. economy picking up at an accelerated pace of 4% in Q2 and the U.S. labor market improving, concerns over an interest rates hike sooner than expected are high. This has lowered the appeal for risky yield plays.
This is especially true, as high-yield funds shed $7.07 billion in the week ended August 6, including $1.3 billion in ETFs. The outflow surpassed the previous record of $4.6 billion that was pulled out in the week ended June 5, 2013,according to Lipper. Notably, junk bond funds saw about $1.14 billion and $5.4 billion in outflows in June and July, respectively.
In fact, the ultra-popular junk bond ETF – iShares iBoxx $ High Yield Corporate Bond ETF (HYG) – saw a massive outflow of more than $1.2 billion over the past four weeks, followed by $939.4 million in PIMCO 0-5 Year High Yield Corporate Bond (HYS) and $509.3 million in SPDR Barclays Capital High Yield Bond ETF (JNK). The ETFs were down 1.6%, 1.2% and 1.7%, respectively, in the same time period.
Volatility crept up in the past few weeks. Rising geopolitical tension in Russia, ongoing violence in the Middle East, a bloody Gaza strip, Argentina default, Portuguese banking woes, Chinese slowdown and a struggling European economy dampened the demand for riskier assets, including equities.
Further, the Fed monetary policy report last month raised concerns about stretched valuations in the lower-rated corporate debt space. The International Monetary Fund also highlighted the weakness in this high yield space, suggesting that more pain is in store for this asset class.
If this wasn’t enough, record low yields, declining market liquidity as well as stringent regulations and higher capital requirements by the banks could derail the high-yield debt market further in the coming months. As a result, investors are shifting their preference to the ‘safe haven’ fixed income world avenues such as German Bunds and U.S. Treasuries (read: Safe Haven ETFs to Evade Geopolitical Tensions).
What Should Investors Do?
While short-term Treasury bond ETFs generally provide a decent option to play in the current turmoil, mid and long-term Treasury counterparts could emerge as true winners. This is because the yield on the 10-year Treasury note has presently dropped to a 14-month low at below 2.4%. Meanwhile, the yield on the 10-year German government bond has fallen to a record low near 1%.
Investors could consider long-term Treasury ETFs such as iShares 20+ Year Treasury Bond ETF (TLT) and Vanguard Extended Duration Treasury ETF (EDV). TLT gathered more than $399.6 million over the past four weeks, propelling its total asset base to more than $4 billion. The fund is the most popular and liquid ETF in the long-term bond space and tracks the Barclays Capital U.S. 20+ Year Treasury Bond Index. Average maturity comes in at 27.13 years and the effective duration is 16.92 years.