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Investors Eye High Yield Mutual Funds Amid Economic Uncertainty
Investor Interest in High Yield Mutual Funds
Investors are cautiously exploring high yield mutual funds and exchange-traded funds (ETFs), attracted by the promise of higher returns despite the associated risks. Barclays reported inflows of $1.9 billion into these funds in July, according to Lipper data. This surge of interest contrasts with the total outflows of $11.2 billion projected for 2023. High yield bonds, which are corporate issues rated below BBB, carry a higher risk of default compared to their investment-grade counterparts, making them a riskier investment option.
Market Predictions and Economic Indicators
Investors hoping for a soft landing for the economy found further validation with July's consumer price index coming in below expectations. The inflation metric rose 3.2% on an annualized basis, lower than economists' estimates of a 3.3% gain, according to Dow Jones. However, concerns about corporate defaults persist. Fitch Ratings projects that the U.S. high-yield default rate will trend higher, reaching between 4.5% and 5% by the end of 2023 due to increased interest expenses and tighter lending conditions.
Optimism Amid Uncertainty
Despite the risks, some remain optimistic about the high yield asset class. Bill Zox, a portfolio manager for high yield and corporate credit strategies at Brandywine Global, noted that management teams have been preparing for higher interest rates and potential recession for over a year. He believes that the high yield market will not repeat the patterns of the global financial crisis or the tech telecom bubble of the early 2000s, predicting a more benign environment instead.
Rewards and Risks of High Yield Investments
Investing in high yield can be rewarding for those who can tolerate volatility and are comfortable with a segment of fixed income that can behave like equities. For example, the SPDR Portfolio High Yield Bond ETF (SPHY) saw inflows of $924 million this year, with $588.3 million coming in the past month, according to FactSet. Despite a return of -10.6% in 2022, it has yielded a return of over 6% this year.
Professional Investors' Strategies
Professional investors in the space are selective in their income pursuit. Bryan Novak, senior managing director of Astor Investment Management, stated that they prefer loans – more senior loan positions rather than high yield due to the asymmetric risks in high yield. These senior loans are secured by the issuer's assets and are senior in the company's capital structure, which gives loan holders priority over bondholders if the company goes bankrupt.
Individual investors may not directly participate in the senior loan market, but they can invest through ETFs. For instance, the Invesco Senior Loan ETF (BKLN) has an SEC 30-day yield of 8.35% and an expense ratio of 0.66%. Beyond high yield loans, Astor Investment Management also invests in higher quality investment grade bonds, such as the iShares 5-10 Year Investment Grade Corporate Bond ETF (IGIB), which has a 30-day SEC yield of 5.49% and an expense ratio of 0.04%.
Investment Approach and Allocation
Investors comfortable with the additional risk can allocate a small portion of their portfolio for high yield. Bill Ahmuty, head of the SPDR ETF fixed income group at State Street, suggests that a 3% to 5% allocation toward high yield could be reasonable for investors looking to incorporate some of these assets. However, Lawrence Gillum, chief fixed income strategist at LPL Financial, recommends that clients' fixed income allocation be in core bonds, short duration, and investment grade issues, advising against taking a heroic position in high yield.
Implications for New Businesses
The growing interest in high yield mutual funds and ETFs presents both opportunities and challenges for new businesses. On one hand, the influx of investments could stimulate economic activity and provide businesses with much-needed capital. On the other hand, the heightened risk associated with these investment vehicles could lead to market volatility, which new businesses must navigate carefully.
Opportunities and Risks
The potential for higher returns could attract more investors, leading to increased liquidity in the market. This could provide new businesses with better access to funding. However, the high risk of default associated with these investments could also lead to financial instability, potentially affecting businesses' ability to secure funding.
Preparing for Economic Uncertainties
The current economic indicators suggest a soft landing for the economy, which could provide a favorable environment for new businesses. However, the projected increase in the U.S. high-yield default rate highlights the need for businesses to prepare for potential economic downturns.
Strategic Investment Decisions
The strategies employed by professional investors, such as preferring more senior loan positions, underscore the importance of strategic investment decisions. New businesses must carefully consider their financing options and ensure they have a robust risk management strategy in place.
In conclusion, while the increasing interest in high yield mutual funds and ETFs presents opportunities, new businesses must also be prepared to navigate the associated risks. By staying informed about market trends and making strategic investment decisions, businesses can position themselves for success in this complex financial landscape.
Article First Published at: https://www.cnbc.com/2023/08/10/high-yield-bond-etfs-are-paying-hot-yields-proceed-with-caution.html
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