Buyers of junk bonds are retreating to the market’s more obscure securities as the rise of exchange-traded funds fuels concern that such fast-moving cash is exacerbating price swings.
Investors are delving into smaller, older junk-bond issues that trade less frequently, pushing yields on such securities to the lowest on record, while those on more frequently traded notes are holding above lows reached last May, Barclays Plc data show. Wells Fargo & Co. credit strategists are recommending a list of bonds not owned by ETFs that investors should consider buying to lessen price volatility when everyone from retirees to hedge funds pull cash from them.
The divergence illustrates the force that ETFs have become in the market for high-yield, high-risk debt after amassing more than $35 billion of the securities since BlackRock Inc. started the first vehicle focused on the debt seven years ago. In order to offer investors in-and-out, stock-like access to bonds, the ETFs seek the newest, most liquid debentures as they maneuver in a market typically transacted over the phone.
“You don’t want to be selling when they’re selling, you don’t want to load up on their liquid bonds,” said Marc Gross, a New York-based money manager at RS Investments. “Sometimes you don’t want the market volatility.”
As dealers commit less of their own money to facilitate corporate-bond trading, ETFs are exerting more control over transaction volume that hasn’t kept pace with the market’s growth. Primary dealers that do business with the Federal Reserve cut their corporate-debt holdings by 76 percent since the peak in 2007 through last March in response to risk-curbing regulations.
At the same time, ETFs are blossoming as investors race to riskier assets in less-traded markets as the central bank keeps interest rates near zero for a sixth year. Assets in the 10- biggest junk ETFs have swelled 24 percent since May 2012, according to data compiled by Bloomberg.
“The ETFs allow me to go into markets that are harder to get into,” Bill Larkin, a fixed-income money manager who helps oversee about $500 million at Cabot Money Management Inc., said in a telephone interview from Salem, Massachusetts. “I’m trying to manage risk using ETFs.”
The funds tend to have more influence on trading when sales of new corporate bonds slow, such as last month, forcing investors into the secondary market, according to George Bory, head of credit strategy at Wells Fargo. More than 75 percent of the 200 most-actively traded bonds in February were included among the funds’ holdings, particularly BlackRock’s ETF that trades under the ticker HYG, Wells Fargo research shows.