In the first quarter, Fitch estimates total retail fund flows into high-yield bonds reached $15 billion, with at least 20% of the total resulting from new flows into junk bond ETFs.
“Fitch believes leveraged bond ETFs are improving liquidity and should broaden the high-yield investor base. However, the trend may also contribute to market volatility and potentially de-link some aspects of bond pricing from credit fundamentals,” the firm said.
A large trade in one junk-bond ETF, JNK, this month has attracted attention because an investor apparently used the fund to acquire a large chunk of bonds quietly away from the secondary market. [Will More Big Investors Use ETFs to Disguise Trades?]
“Expanded use of high-yield ETFs as a short-term trading platform will likely fuel more market volatility, particularly in periods of macro stress, when risk re-allocation could drive big swings in ETF flows. In periods of asset inflows such as the first quarter, this should support tighter spreads on new issues, particularly for large leveraged issuers whose bonds must be acquired by ETFs,” Fitch said.
“At the same time, forced selling could be exacerbated by hot money flows during periods when fundamentals are weakening and investors are pulling back from riskier asset classes,” it added. “This has the potential to reinforce liquidity-driven price moves in high-yield bonds that may have little or no relation to changes in credit fundamentals.”