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 $700m that didn't trade that often. Four years on, JNK is a $12billion fund with daily turnover of $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 ($500K-$1m per issue) so that constructing a diversified portfolio of 100+ names required $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 HY market.
This has changed the HY market forever and is the primary reason that the HY market continues to offer solid expected returns despite the significant decline in yields. The reason? HY 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 HY bonds over equities, and allocating their capital accordingly. While some commentators caution that the supply of HY bonds is too low given the inflows, I take the opposite view: corporate treasurers will switch from equity to the HY bond market to raise capital if demand is there and there is a clear cost advantage to doing so.
In my opinion, the HY 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 HY investments decline. This contrasts with most commentators who argue that the HY 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 Streets' equity stars had better start brushing up on their fixed income skills!