Junk Bond Outflows VWEHX: Garbage To Some; A Gem To Others

etfcomlogoAs Junk Bond ETF outflows accelerated in the past 6 weeks, MarketsMuse editor team has been intrigued by two most recent articles profiling where and whether it makes sense (and hence dollars) for high-yield bonds (and respective ETFs) within a portfolio.

Per articles today from RIA Larry Swedroe via ETF.com and front page of WSJ story by Katy Burne, profiling select institutional investors who are jumping in while retail investors jump ship, the yearn for yield remains a hotly-debated topic.

Swedroe says Nyet!: “Historically, the additional risk of high-yield bonds hasn’t been well-rewarded. And today, with credit spreads at historically low levels, the outlook doesn’t look promising. For the best risk-adjusted returns, investors are better off sticking with high-quality bonds.”

Vanguard’s High Yield Corporate Fund (VWEHX) returned 8.8 percent per year. By comparison, the Barclays Credit Bond Index Intermediate returned 8.3 percent per year over the same period.

If you need more risk (return) in your portfolio, you’re better off taking that risk with stocks, where you can diversify those risks more effectively and earn returns in a more tax-efficient manner.”

Since there are always 2 sides to every story, Katy Burne’s piece starts with:  Large institutions are snapping up U.S. junk bonds, taking advantage of a price slide triggered by an exodus of individual investors. Many big money managers say they remain bullish on these risky corporate bonds despite concerns that the market is overheated and worries that geopolitical unrest could fuel a rush to safer assets.

Their interest stands in contrast to a wave of selling by retail investors, who sucked almost $13 billion out of junk-bond mutual funds and exchange-traded funds in the four weeks ended Aug. 6. Analysts said upheaval in Ukraine, Iraq and Israel unsettled some investors, and concerns that prices were already too high drove some smaller investors to sell. They worried that the multiyear record-breaking run of junk bonds might be near an end.

That presented a buying opportunity for larger investors, who say the $1.6 trillion U.S. junk-bond market remains healthy and note that many bonds are now cheaper than before. While there are no hard data to show hedge funds and large asset managers moving into junk bonds, a rise in prices last week suggested some big firms were buying, analysts said. U.S. high-yield bonds returned 1.02% this month through Friday, according to Barclays PLC, pushing year-to-date returns to 5.112% as of Friday from 3.498% as of Aug. 1.

The conviction of these investors is notable in part because of the huge rally in junk bonds—those issued by companies with credit ratings below investment grade—in recent years. Since the end of 2008, these bonds on average have returned 150%, including price increases and interest, according to the Barclays U.S. corporate high-yield index. The Dow Jones Industrial Average is up 90% over that period, including price moves and dividends.

Institutions that purchased high-yield debt during the 2013 selloff made profits when the market roared back from what became known as the “taper tantrum”—alluding to the Fed’s signal that it was contemplating ending its bond buying. But last month, junk-bond prices tumbled, sending the debt to its worst monthly returns in over a year.