In the last few weeks we have seen the first real pullback in credit spreads since March (+70bps wider so far to +510bps for our core BB/B GHY index). What is interesting is that flows have almost entirely been dominated by ETFs.
Unpacking the technicals
First, it’s worth a reminder that ETFs probably increased liquidity in the crisis period at the cost of greater volatility. We saw volumes in the market rise markedly in March (by a factor of three) and undoubtedly the forced price discovery increased the volatility we saw in March. This led to the quickest sell-off ever (the market went from 330bps to over 1000bps over four weeks). We think this speed of selloff led to the unprecedented policy response from the Federal Reserve as they worried a credit crunch would result. As a result, their intended support included high yield ETFs, recognising the important part these instruments play in transmitting volatility across the high yield market. The unintended consequence of this Fed action was that the AUM of ETFs increased markedly. We saw the largest high yield ETF (JNK) double its AUM, in fact even compared to prior to the crisis assets were 50%+ larger at $31.5bn by the end of July compared to $19.3bn at the beginning of the year. Staying with JNK the AUM has fallen by $5bn over the last month to $26bn, with $3bn exiting this last week alone. In the context of a $1.2 trillion US high yield market (and a $2 trillion Global high yield market) this ETF is insignificant, but ETFs are important as their flows tend to be lumpy, with that $5bn accounting for almost half the monthly average trading volume in US high yield.