Friday, January 27, 2012

The fundamentals behind strong HY fund flows

Following up on the post about HY fund flows, the amount of new cash hitting the system has not only been unusually high, but also consistent on a daily basis.  As the chart below shows, we only saw one day of net outflows.


Source: EPFR

Here is the year-to-date cumulative net inflow ($7.4 bn YTD.)

Source: EPFR

It is clear that zero rates is one reason for these inflows, but what about fundamentals of the HY market? Are they really that attractive? Three items driving fundamentals are worth mentioning:

1. Defaults continue to stay near record lows and spreads seem interesting on a relative basis.

Source: JPMorgan

2. Leverage on in HY corporations in the US remains stable.

Source: JPMorgan

3. US corporations' liquidity, even at leveraged companies, has been rising steadily in the last few months (hat tip Royal Arse)

Source: JPMorgan

But even with these strong fundamentals, the speed of inflows we are seeing is unlikely to be sustained for long. The trend is somewhat troubling because a good portion of these flows is coming from retail investors. Some of the more leveraged names, particularly in the CCC range are still quite vulnerable to global economic shocks. Given the recent rally (the US JPM HY Index is up 2.8% YTD), the overall sector could sell off sharply with a sudden surprise out of Europe.


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