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Federal Reserve Chair Janet Yellen tried to alleviate fears surrounding the heightened stress seen in high-yield bonds Wednesday, by downplaying the shuttering of a number of Wall Street junk bond funds that took place last week.
Investors and analysts looking at the space now expect volatility to remain at elevated levels for the year ahead, with mixed views on whether junk bond weakness poses a risk to other pockets of the market in 2016.
Following the Federal Reserve's decision to raise rates by 25 basis points on Wednesday, Yellen said the Securities and Exchange Commission (SEC) had been in touch with Third Avenue, the high-yield credit fund that was forced to put redemptions on hold last week.
The move to block withdrawals from Third Avenue and fellow credit funds Lucidus and Stone Lion helped fuel a junk bond sell-off as investors attempted to pull their money from battered funds.
"Redemptions in high-yield bond funds have been increasing in recent months," Yellen said at Wednesday's press conference.
"But the Third Avenue credit focused fund was a rather unusual open-end mutual fund. It had very concentrated positions in especially risky and illiquid bonds and it had been facing very significant redemption pressures," she added.
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.
Chief investment strategist at BlackRock, Stephen Cohen said high-yield ETF (exchange-traded fund) pricing has "done exactly what you would expect" following the junk bond sell-off, which resulted in record trading volumes in the largest high-yield ETFs, including BlackRock iShares HYG.
"I don't think Third Avenue is really reflective of what they (high yield)) were doing. I think one of the differences here is that it is described as a high-yield fund. A lot of the constituents of the fund were very, very low grade, non-rated, very illiquid securities," Cohen told CNBC.
"It was a huge test, if you look at the volumes, we had $4 billion on Friday in HYG. But the vehicles traded exactly how you would hope them to trade. I think really importantly – you have seen new types of investors move to these vehicles, so you are seeing a big two-way market," he added.
Fixed income asset management specialist Western Asset Management, which manages around $446 billion, said it was still keen on the high-yield space, even in the energy sector, despite recent fears.
"(The) high-yield exploration and production (E&P) industry offers attractive risk/reward investment opportunities. Valuations within the asset class cheapened significantly in 2015, in particular within the E&P industry. While some companies will not be able to sustain low energy prices, Western Asset believes defaults will be less than half of what valuations imply," the group said in a statement.
But there are still a number of notable and noisy junk bond bears warning of the wider implications that the weakness in high yield could have for other asset classes, even as the market has stabilized in recent days.
Renowned bear and Societe Generale strategist, Albert Edwards said the recent issues in the corporate bond market come as no surprise and the issue is not just contained to the energy space, which has been severely weakened due to the tumbling oil price.
"Spreads were also widening noticeably even if the energy sector was excluded. The party is over and bond investors always tend to be more sober types, realize this and have headed for the exits, whereas equity investors are still gyrating around the dance floor – just as in 1999 and 2007," he said in a research note, published Thursday.
HYG and State Street's JNK ETF, which collectively amount to over $20 billion in assets, reversed earlier gains, with both trading around 0.5 percent lower on Thursday, having both bounced over 1 percent earlier in the week.
But fixed income manager at Jupiter, Ariel Bezalel said the material outflows witnessed from U.S. high-yield funds are cause for concern. He has limited exposure to U.S. high yield and has trimmed European junk bond exposure on contagion fears.
"The other concern we have had for a while is some sort of contagion to European credit, as credit in emerging markets and U.S. credit have continued to come under pressure. For this reason we have been reducing our European high-yield exposure and within our high-yield bucket we have been improving the quality and also preferring shorter-dated paper," he said.
"Recent events justify why we have adopted this barbell approach of having our top picks across high yield (primarily European high yield) countered by high quality investment grade credits and a material position in high quality government bonds such as U.S. Treasurys, Australian government bonds and New Zealand government bonds," he added.