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Bond investors dump the junk

Speculative-grade debt was shunned by investors last week with new data showing that high-yield bond funds saw their largest outflows for over a year.

A report from Bank of America Merrill Lynch on Friday showed $4.8 billion was dumped from these global funds in the week ending Wednesday July 23, the most seen since June 2013. It also noted that high-quality fixed income had seen 31 straight weeks of inflows which it warned was at risk of being overcrowded.

High-yield bonds, otherwise known as speculative grade or junk debt are bonds issued by companies that carry a rating of 'BB' or lower from Standard & Poor's or 'Ba' or below from Moody's. They have a higher risk of default compared to investment-grade debt but give a better return for investors as yields are higher.

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Many analysts believe that yield-hungry investors have flooded money into the space with record low interest rates at central banks causing high-quality bonds to become less attractive. U.S. fund tracker Lipper also stated on Friday that its own high yield funds classification had a second consecutive week of net outflows with almost $2.0 billion pulled in two weeks.

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The fall comes after an impressive rally in the asset class in the last few years despite the occasional blip. High yield corporate bond deals worth more than $1 billion have hit a record since the start of the year, according to research firm Dealogic. Data from the same firm shows that corporate high-yield issuance and issuance from financial institutions is set for its worst month since February.

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Daniel Lacalle, a senior portfolio manager at investment management firm Ecofin, believes that this good performance could now be driving the profit-taking. But he added that the anticipation of rate hikes by central banks like the U.S. Federal Reserve could also be fueling the move.

"With more probabilities of interest rate hikes, high yield becomes less attractive, driving a 'flight to safety' as yields on single A (rated debt) and sovereigns improve," he said.

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"I see it actually as a healthy sign of normalization of expectations regarding extremely dovish monetary policies. Market sees a 'return to normal' which reduces the appetite for risk and the search for yield regardless of risk."