Outflows From Credit ETFs Are an Ominous Sign

(Bloomberg Gadfly) -- It's been an amazingly good year for top-rated companies to borrow money. Until now. Suddenly, the mood is changing in a significant way.

Traders have yanked billions of dollars from the biggest corporate-debt exchange-traded funds in the past week. While some big flows in and out of these funds can be hard to interpret, these appear to stem from a real shift in sentiment.

First of all, it's not just one ETF. Yes, the biggest junk-bond ETF recently experienced a record one-day outflow and has increasingly become a hotbed of activity.

But the largest investment-grade ETF also has seen more than $2 billion of withdrawals in the past week, among the bigger ones in its history, as Brean Capital's Peter Tchir recently pointed out. U.S. corporate-debt ETFs have experienced more than $4 billion of outflows combined in the past week.

Not only is money coming out of these funds, but investors are showing skittishness in other ways, too. For example, it's getting more expensive to hedge against losses using credit-default swaps, and yields on corporate bonds have sharply risen in the past few days. U.S. investment-grade bonds just had their worst monthly loss in more than a year. Dollar-denominated junk bonds have seen a 1 percent decline in the past week alone.

It seems that investors have finally grown tired of locking up their money in increasingly leveraged companies. It took them long enough; they've already gobbled up a record amount of new, investment-grade debt so far in 2016 and helped fuel an unprecedented spate of mergers. And they've accepted relatively meager yields for taking the risk.

Outflows from U.S. corporate-debt ETFs in past week

$4 billion

So is this the start of a bigger selloff? Credit traders are clearly already starting to get jumpy as benchmark borrowing costs rise. 

Indeed, one of the biggest arguments for buying corporate debt has been that government bonds were providing such little yield that riskier credit looked much more appealing. That's a less compelling argument now. The longer that U.S. and European government bonds continue to lose value, however slowly, the more investors will keep backing away from these riskier notes. Many investors are well aware of that; some are trying to get a head start on getting out of this debt before competitors.

Sometimes it's wise to ignore big flows in and out of big ETFs. They can be noisy, especially as more institutions use the funds as a way to quickly allocate money for a variety of reasons. But this slew of withdrawals feels like something more significant.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net.

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net.