Rather than scouring the universe of high-yield corporate debt for specific issues, hedge funds are increasingly turning to exchange traded funds for exposure to junk-rated corporate bonds.
ETFs such as the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the two largest junk bond ETFs by assets, are easier ways for hedge funds to navigate “illiquid corporate debt as trading slumps relative to the market’s size,” reports Lisa Abramowicz for Bloomberg.
In the fourth quarter, hedge fund Hutchin Hill Capital, bought $431.4 million shares worth of HYG while Pine River Capital Management bought nearly $197 million worth of JNK, according to Bloomberg. Amid a surge of inflows to bond ETFs to start 2015, only one ETF has brought in more new assets than the $2.9 billion that has flowed into HYG. JNK has added $1.7 billion in new assets, a total that surpassed the inflows to all but eight ETFs. [Record Inflows to Bond ETFs]
Increased flows to junk bond ETFs come as some market observers remained concerned about the high-yield market’s liquidity. HYG, JNK and other junk bond ETFs trade on exchanges, just like stocks, but those ETFs’ holdings “still trade through an over-the-counter market that’s increasingly strained as Wall Street’s biggest dealers reduce their traditional role as market makers,” according to Bloomberg.
Investors’ concerns have centered on ETFs tracking less-liquid sectors of the fixed-income market, such as corporate junk bonds and muni bonds. Due to increased regulations, a consequence of the Dodd-Frank Act, banks face more scrutiny on balance sheets, leverage and capital. That has sparked increased usage of ETFs for fixed-income exposure in place of derivatives. [Institutions Increasing Use of ETFs]
The theory often bandied about is that in times of high market stress, when a slew of investors could be rushing for the same exit at the same, junk bond ETFs could subject investors to wide bid/ask spreads, significant deviations from their underlying net asset values and other unsavory circumstances.