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Are high yield and emd fates diverging

Since summer last year, the correlation between high yield and emerging market bonds has reversed.


Net inflows by European investors into both asset classes, which are provided to us by Morningstar on an monthly basis. suddenly turned negative in the summer of 2013 following the announcement of monetary policy tightening in the US High yield bonds quickly returned to favour with investors, but emerging market debt continued to suffer outflows until the beginning of last year.

Different fortunes

However, now fates seem to have reversed. While emerging market debt has registered steady net inflows each month since March, high yield net inflows have come down consistently since October last year. By July, they had fallen negative for the first time in more than a year (see graph below).


The fund flow movements seem closely connected to the valuations of both asset classes. While high yield spreads have almost continuously tightened further for the past three years, emerging market debt as an asset class suffered a serious setback in June 2013, with prices only starting to really recover in early spring this year (see graph below). This was a sign for many fund selectors in Europe to consider investing in the asset class again, and to take profit on at least some of their high yield exposure.


High yield sell-off

“We sold our high yield positions in May this year, and added some emerging market debt”, says Rico Bosma, a fund analyst from Wealth Management Partners in The Netherlands. And Bosma is not the only European fund selector who has made such a move. Several of his compatriots, such as Rishma Moennasing, an equity analyst for Rabobank, also replaced high yield with emerging market debt. Our researcher who visited fund buyers in Munich this September saw a similar trend, which is actually set to continue.

Both in Munich (see pie charts below) and The Netherlands, emerging market debt is relatively popular, with interviewees intending to increase their exposure clearly outnumbering those who plan to sell. The opposite is true for high yield: 50 respectively 41% of interviewees in Munich and The Netherlands intend to sell, while almost none say they will step up their allocation to the asset class.


So have emerging market debt and high yield split ways for good? “A year or two ago yields for high yield and emerging market debt were comparable, and for fund flows to retake their former pattern they would need to converge again,” says Bosma. “But for that to happen, we would either need a substantial rally in emerging market debt, or high yield prices would need to come down significantly.”

The data for the EIE Historic Fund Flows Database are provided by Morningstar.