Demand for junk bonds ebbs as investors rein in risk-EPFR

By Sam Forgione

NEW YORK, Oct 5 (Reuters) - The year-long rally in junk bonds hit a bump in the road this past week, with investors beginning to show concern about high-yield debt valuations, analysts said.

Fund tracking firm EPFR Global reported Friday that investors pulled $410 million out of junk bond funds, the first outflows from high-yield debt funds in 17 weeks.

Michael Jones, chief investment officer of RiverFront Investment Group, said investors are beginning to worry about the valuations on high-yield bonds and whether they are taking on too much risk.

The retreat from junk bonds comes at a time when investors are searching for higher-yielding assets in the wake of the Federal Reserve's move to push down borrowing costs by buying up $40 billion in mortgage securities a month. But the outflows may indicate that, in searching for yield, investors are still being discriminating in their buying.

Investors "are not ready to make the massive, the-world-is-OK trade," said Colleen Denzler, global head of fixed income strategy at Janus Capital Group, with over $152 billion in assets.

That may explain why U.S.-focused stock funds saw $3.37 billion in outflows in the period ending Oct. 3, according to EPFR. And U.S. bond funds that don't invest mainly in junk bonds took in $2.54 billion in new money.

Globally, bond funds took in $5.53 billion during the period.

The outflows from stock funds came even as the benchmark S&P 500 's rose 1.23 percent during the reporting period. O n Friday, the benchmark 10-Treasury note was yielding 1.7288 percent.

But investors didn't abandon the appetite for risk and yield altogether.

Emerging market bond funds took in $1.05 billion in new money. And bond funds that hold risky European bonds attracted a modest $287 million.

The yield and performance of emerging markets bond funds continue to drive inflows, said Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock Inc.

The Barclay's Capital Global Emerging Markets Index is up 15.09 percent for the year, according to Lipper.

The choppy asset allocations reflect continuing concern about the strength of the U.S. economic recovery and the ability of Spain and other European nations to deal with their fiscal woes.

On Friday, the news from the U.S. Department of Labor that the nation's unemployment rate dropped to 7.8 percent, a near four-year low, could provide a lift to investor confidence in coming weeks.

In intraday trading following the release of the jobs numbers, the yield on the 10-U.S. Treasury rose to 1.73 percent, up from 1.63 percent earlier in the week. The jump in the yield is an indication that some investors believe a stronger U.S. economy could lead to more inflation.

But not all analysts are convinced the better-than-expected jobs numbers will have much lasting impact on investors.

"While that's an improvement, it's just not as big of an improvement in the labor market that the headline decline would otherwise suggest," said Rosenberg of BlackRock, who pointed out that participation rates remain low and that part-time jobs accounted for much of the improvement.

(Editing by James Dalgleish)