The entire U.S. fixed income market (municipals, Treasuries, mortgages, corporates, federal agency bonds, money market, and asset back securities) totals over $40 trillion.1
Breakdown of U.S. Fixed Income Asset Class (as of December 31, 2016)
Corporate credit (high grade corporate bonds, high yield corporate bonds, and floating rate loans) is about $8.9 trillion of this pie. The high yield bond market is a large and growing market, now totaling $1.5 trillion in the U.S. and $2.0 trillion of U.S. dollar denominated high yield debt globally.2
If you add in high yield floating rate loans, that includes another nearly $0.9 trillion and together high yield bonds and loans account for nearly 30% of corporate debt. One thing is clear, that the high yield debt market is a growing market, and we believe one that cannot be ignored for fixed income investors.
As we look at just who owns high yield bonds, the three largest categories of owners are pension funds, insurance companies, and retail mutual funds, all of which have relatively similar size of ownership at just over a quarter of the market each.3
With this we see both institutional and retail customers as active in the space. At $42.1 billion, high yield exchange traded funds (ETFs) account for about 14.2% of the total $296 billion “retail” high yield fund base4, which includes the much larger mutual fund counterpart. High yield ETFs account for about 2.8% of the broader U.S. high yield market and have been around that level for the last five years, and loan ETFs are just over 1% of the total US loan market.5
While a very small portion of the total market, the place of high yield ETFs within the broader high yield bond market has been a discussion point over the last couple years, with some critics speculating that some widespread sell pressure in high yield ETFs could cause a collapse in high yield markets due to “liquidity” issues. We have previously explained how regulations post the financial crisis have led to less market making and lower dealer inventory of bonds, and the impact that has had on markets (see our piece “Understanding Market Liquidity”, “The Pricing Issue in High Yield“).
Flows in and out of these “retail” mutual and exchange traded funds (though we know that various institutions are buyers of mutual funds and ETFs as well) can be volatile week over week, but again, these flows pale in comparison to size of the total market. For instance looking back over the last year and a half of weekly retail exchange traded and mutual fund flows (chart below)6, the second largest reported weekly retail outflow on record occurred in March 2017 and totaled around $5.68 billion.7 This amount compared to a $1.5 trillion U.S. high yield bond market means it is about 0.4% of the total market, so seemingly minuscule.
Over this period, the largest ETF-specific weekly outflow (and the largest ETF outflow on record) was $3.45bil8, so only about 0.2% of the total U.S. high yield market size. Last week we saw the third largest ETF-related daily outflow on record and with that, the high yield market was down only 0.25%9, which certainly indicates that the market was able to handle the large ETF outflows without any significant disruption.
Not only do we see ETFs benefiting from their in-kind redemption mechanisms, in this environment of lower dealer inventory and heightened price volatility, we believe that high yield ETFs provide an advantage over mutual funds during more volatile times because ETFs trade/price intra-day, so we would argue provide a more accurate and true pricing mechanism for going in and out of the high yield market than mutual funds that only trade at the end of the day.
We see the high yield bond and loan market as an important piece of the fixed income asset class, especially in this global low yield and high domestic equity valuation environment. We believe that high yield ETFs provide investors great accessibility to the asset class. And while the post financial crisis regulations may add an element of volatility to the market, we would view this volatility as an opportunity for active managers like Peritus who have the ability to capitalize on discounts and can be intentional about the credits they invest in. While we have seen a strong year plus for the high yield market, we believe that there are still attractive opportunities within the high yield space for active managers who are able to search for value.