Wednesday, November 25, 2009

>Which bonds will struggle when fund flows reverse?

The tailwind of mutual fund flows
Net inflows into corporate bond mutual funds have had a big price impact over the past year – bigger, we think, than most investors generally realize. When these flows stabilize, as they obviously will at some point, or possibly reverse, we see a potential softening or reversal in performance for those names that have so far outperformed due to the technical pressure from mutual fund inflows. This concern motivates the bond-level investigation which is the focus of today’s Credit Line.

Bonds exposed to flow reversals
Our bond-level estimates indicate that credit with high “flow betas” are both lower-rated and more cyclical. We use our estimates of flow beta to screen for the bonds in both IG and HY with the highest sensitivity to mutual fund flows. These bonds have substantially outperformed the
market since the bottoms in March, and we expect they would soften disproportionately when mutual fund flows stabilize (or even reverse).

Still long Sterling
Sterling-denominated corporate bonds have recently underperformed on hawkish comments by the BoE and rising long-term rates. We continue to like the Sterling space, given its higher spread valuations and liquidity premia compared to other currencies. We also think carry and spread tightening should compensate for potential increases in rates. We reiterate the buy recommendation on our long BBB sterling basket.

To read the full report: CREDIT STRATEGY