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Robust Junk Bond Market Questions 'Great Rotation'

Thursday, 28 Mar 2013 | 1:03 AM ET

Despite talk of the so-called "great rotation" out of bonds and into equities, activity in the high yield debt market has been robust, with issuances climbing to a quarterly record high in the January to March period.

Global high yield bond issuances reached $148.6 billion in the first quarter - 25 percent higher from the same period a year earlier - led by the U.S. U.K. and China, according to data provider Dealogic.

High-yield debt, also known as junk bonds, are fixed-income instruments with a rating of 'BB' or lower by Standard & Poor's, or 'Ba' or below by Moody's, and have a greater risk of default compared to safer investment-grade bonds.

(Read More: Moody's Stabs S&P in the Back With a Near-Junk Rating)

"There's an ongoing bid for junk bonds because people are searching for yield; that demand is going to continue. There isn't that much supply [of high yield debt] out there," Stephen Nash, director of strategy and market development with bond broker FIIG Securities told CNBC.

"While the spread has narrowed between junk and investment grade bonds, which is a concern, people are happy to go into something that has some of type of security," he added.

Heavy inflows into funds purchasing these securities has led to a considerable narrowing in the spread between the yield on junk bonds and U.S. Treasurys over the past year. The yield on the benchmark 10-year Treasury note stands at 1.83 percent.

(Read More: Watch Out! Reversal of the 'Great Rotation' Coming)

A low interest rate environment has supported the junk bond market, enabling companies that are less financially sound to get low-cost financing at a time when investors are searching for yield.

Anita Yadav, managing partner at corporate bond brokerage and asset management firm SJ Seymour Group expects issuances in the high yield space globally in 2013 to surpass levels seen last year, given robust investor appetite.

She noted that in Asia, private banks, who a few years ago did not account for a significant portion of demand in this space, have emerged as a strong source of demand.

(Read More: Fed Throws Junk Bond Lifeline to Weak Companies)

"Investors are rushing to put money to work on the assumption that market problems are over," she added.

However, Yadav, who is cautious on this space, said among the biggest risks is that investors are ignoring details in the individual issuers amid the current market "euphoria."

(Read More: Drunk on Junk: Why We're Rushing to Risk)

"As people rush into the space, selection analysis tends to become a bit relaxed. Which later on can hurt them," she said.

In addition, from a valuation perspective, the junk bond market in Asia as a whole looks slightly overvalued, Yadav said, adding there is not much upside from current levels.

"If I'm a long term investor, with a one and half to two year horizon, I wouldn't be investing in half these names. If my time horizon is 6 months, it looks ok as there is an imbalance between supply and demand," she said.

Great Rotation

According to Yadav, expectations for a seismic shift to equities from bonds are overblown. What is more likely is that money will shift out of cash into stocks, she said.

(Read More: Philippines Wins First Investment Grade Rating From Fitch)

"There may be some leakage from fixed income but it will so gradual, that it will unlikely have a catastrophic effect on the fixed income market," she said.

Nash agreed, noting, "I don't buy the rotation story at all - we haven't seen large selling of bonds to go into equity for our clients."

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