When I ordered 20,000 shares in State Street’s High Yield ETF (ticker JNK) in 2009, my broker was concerned that the order was too large to complete in a day without moving the market. JNK was a relatively new vehicle with a market cap of USD 700M that didn’t trade that often. Four years on, JNK is a USD 12B fund with daily turnover of USD 300M and is the preferred hedging vehicle for High Yield investors seeking liquidity. What has happened to the High Yield market?
High Yield used to be open only to a few privileged institutional investors. This was mainly because the bonds traded in relatively large parcels (USD 500K – USD1M per issue) so that constructing a diversified portfolio of 100+ names required USD 200M to start. Unlike in the equity markets where trade lots are much smaller, retail investors were largely excluded from High Yield. ETF’s like JNK broke down this barrier and now Mr and Mrs Mainstream investor can access the High Yield market.
This has changed the High Yield market forever and is the primary reason that the High Yield market continues to offer solid expected returns despite the significant decline in yields. The reason? High Yield bonds dominate equities in return per unit risk. After a decade of extremely volatile stockmarkets with lacklustre overall returns, retail investors are expressing their preference for High Yield bonds over equities, and allocating their capital accordingly. While some commentators caution that the supply of High Yield bonds is too low given the inflows, I take the opposite view: corporate treasurers will switch from equity to the High Yield bond market to raise capital if demand is there and there is a clear cost advantage to doing so.
In my opinion, the High Yield market is undergoing a significant structural realignment that will see the proportion of debt financing on corporate balance sheets rise and the long run risk premium for High Yield investments decline. This contrasts with most commentators who argue that the High Yield market is at best fairly priced, or more commonly that it is cyclically over-bought. At the same time, it is reasonable to expect that the size of equity markets will fall. The Street’s equity stars had better start brushing up on their fixed income skills!