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Junk Bonds Take a Dive

What would you do if you had around $800 million in cash and you wanted to buy some junk bonds…but you didn’t want anyone to know who you were or what you were doing…and you wanted to avoid fees? The answer: build up a position in a junk bond exchange traded fund by buying shares in increments, then redeem the shares all at once for the underlying bonds instead of cash.

And that’s exactly what one anonymous investor did. After establishing a position in the SPDR Barlcays Capital High Yield Bond Fund (JNK), the investor redeemed almost 20 million shares on May 10th…for just under $800 million in high-yield bonds (JNK is a ‘redeem in kind ETF’, meaning that investors have the option of choosing to redeem the bonds instead of cash).

You could say it was a smart trade. The investor remained anonymous, and kept costs down since buying all of the bonds on the secondary market would have resulted in pretty significant brokerage and transaction fees.

But the trade turned a lot of heads. It was the biggest redemption in the $12 billion fund’s history…and amounted to something like 6.5% of assets. The result was a huge outflow from the fund.

Before that, junk bonds were having a good year…with investors hunting for yield propping up the market. Investors poured $15 billion into junk bond funds in the first quarter, and $1.84 billion in the first week of May. But last week, investors pulled $3.05 billion out of junk bond funds globally (the biggest outflow since last August). In the US, investors pulled $1.97 billion.

It looks as if investors are doing a bit of an about-face on junk bonds – leaving as swiftly as they entered. And it could very well be that the outflow resulting from the JNK trade scared some retail investors away from high-yield debt, and what has happened over the past couple of weeks is a snowball effect.

Still, JNK has been thrown into a short-term downtrend (with net outflows of $452 million last week, and $871 million the week before). None the less, its long-term buy signal is still technically intact.

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