Another issue is that high-yield bonds correlate rather strongly with the MSCI World (see chart below). At a time when political risk in developed markets is high and investors are cautious to commit more money to European, US as well as Japanese equities, it’s hardly surprising that high-yield bond fund flows are lacklustre as well.
But emerging market debt and high-yield could soon change roles. According to preliminary fund flows figures gathered by the Institute of International Finance (IIF), emerging market debt funds saw their first outflows since June last month. The bulk of those came from emerging Asia and the Middle East, regions where companies have relatively high exposure to dollar loans.
The fate of emerging market debt remains closely tied to Fed monetary policy, and as the market moves to further price in a Fed rate hike, the asset class may well fall out of grace as quickly as it has risen in popularity this year.
And appetite for high-yield bonds could increase instead, if inflation finally starts to pick up thanks to a sustained increase in the oil price. The latter would improve the fundamentals of many a high-yield issuer, and reinforce the hunt for yield among investors confronted with a pick-up in inflation. If developed market economic growth continues to surprise to the upside as it has done recently, all is in place for the asset class to blossom.
