How are Investors trading Fixed Incomes?
Do the fund inflows and outflows tell us something?
In one of my previous posts, I explained how Treasury bonds (T-Bonds) are a better investment strategy over junk bonds, also called high yield bonds. Although junk bonds can provide a higher yield, the return is sub-par because of the risk these bonds pose. They could be hit by ratings downgrades, defaults, and a squeeze in company earnings.
A lot has happened since I wrote my rationale. Silicon Valley Bank collapsed last week (March 10th, 2023). I explained my analysis on the collapse in my last post. First Republic Bank had a $30 billion deposit infusion from 11 big banks to prevent it from collapsing (March 16th, 2023). Today (March 19th, 2023), UBS agreed to buy Credit Suisse, its biggest rival, for about $1 billion. Although Credit Suisse's shares closed at $1.86 Swiss francs on Friday, equity investors will be getting paid $0.25 Swiss francs for each share (an 85% discount). This deal essentially wipes out the Credit Suisse equity investors who would be shuddering at the valuation. These events have further aggravated the volatility and turmoil in the banking sector.
While I am staying away from high yield bonds, I also want to validate if the market agrees with my sentiments.
High yield bond funds faced an outflow of $11.5 Billion in February as shown in Chart 1
Chart 1: Funds outflows into high yield bonds.
Treasury bonds have seen an inflow of $15.2B in February as shown in Chart 2.
Chart 2: Funds inflows into high yield bonds.
There is a surge in outflows of high yield bonds and a surge in inflows of government bonds. My investment strategy broadly aligns with the overall market.
Considering the high volatility and numerous uncertainties present this year, I have decided to persist in purchasing 1-Year Treasuries that are set to mature in early 2024. Although the current inflation rate surpasses the 5% return I will receive on my investment, I find comfort in the fact that equities are undergoing tumultuous times. Additionally, investing in Treasuries poses zero risk and is exempt from state tax. Given these factors, I believe this is the most prudent strategy to adopt. I will patiently wait for the tumultuous period to subside. 1 year is enough time to gives enterprises who have debt maturing in 2024 (8%) more breathing room to navigate a slowdown as shown below.
Chart 3: US junk debt and its maturity
I will potentially increase my exposure to higher yield in 2024 and 2025 once the Fed has reached its terminal rate, and companies start to reissue their debt. With a more robust economy, stable default rate, and higher spread over Treasury bonds, the math is more likely to work, as explained previously.
I will conclude with a quote from Warren Buffett - “Don’t pass up something that’s attractive today because you think you will find something better tomorrow.”