Investors still snap up junk, but ardor for investment-grade debt could cool.
The second-half rallies in the high yield and investment grade bond markets gave treasurers welcome sources of funding to replace scarce bank lending. But the fundamentals of both markets were somewhat obscured by the scale of transaction volumes and near frenzied search for yield among investors. It now appears that some degree of caution is returning to the investment grade sector, at least.
The junk sector continued to enjoy record retail inflows into bond, loan and related funds and ETFs in late December. Junk bond vehicles saw net retail inflows of about $21 billion last year, the best showing since 2003, according to Lipper FMI. Retail loan funds saw a net inflow of $3.37 billion. Investors drawn by the junk sector’s 50 percent-plus returns and estimates of lower defaults in 2010 seem willing to continue to bet on weaker borrowers.
The investment-grade bond market has also seen record global issuance in the past 12 months, and spreads have come in sharply. This has put them, more or less, in line with the historical averages for the major bond indices. That, and the lack of clarity regarding bond fundamentals, has caused some big buyers to rein in their purchases. Pimco’s bond strategist Paul McCulley, for example, recently wrote that the massive fixed-income investor plans to moderate its corporate (as well as US and UK government) debt purchases until pricing and economic fundamentals become clearer.
Meanwhile, the sharp steepening of the yield curve indicates investors are getting worried about the inflation a nascent recovery could bring with it—given the massive amounts of liquidity sloshing around the markets. These sorts of concerns tend to resonate with professional, investment-grade fixed income investors earlier than they do with yield-seeking retail junk investors. Granted, the investment-grade sector of the capital markets is likely to continue to welcome strong borrowers. But the days when investors would throw money at any deal on offer appear to be coming to an end.