OREANDA-NEWS. The smallest high-yield (HY) funds suffered disproportionately in the US and Europe during January's outflows from the asset class, according to Fitch Ratings' analysis. European HY funds suffered their largest absolute outflow since August 2011; withdrawals from US HY funds, while significant, were dwarfed by those in December 2015. Anecdotal data suggest funds have partially recovered in February and March. Nevertheless, the flows so far this year indicate that HY fund managers need to brace for more volatile conditions ahead.

European HY funds experienced a net outflow of around EUR1.4bn in January, the largest monthly withdrawal since August 2011, when EUR1.9bn left the sector. Growth of the category in the intervening years means the January 2016 outflow was only 1.5% of assets under management (AUM), compared to 6% in August 2011. In the US, outflows were USD2.4bn in January and USD7.7bn in December 2015. The December figure represents around 3.2% of AUM, close to the 3.7% outflow in August 2013.

In Europe, only one HY fund with AUM over EUR1bn suffered a more than 10% outflow. But outflows among smaller funds were severe in some cases. No US HY fund with AUM over EUR2bn reported more than a 10% outflow.

The higher outflows in smaller funds may reflect several interrelated factors. Smaller funds are more likely to have a niche investment strategy or to focus on lower-quality securities than larger funds. Investors may therefore want to be the first out of these funds if they think outflows will force the sale of safer assets, further increasing the risk profile and weakening liquidity.

We count eight monthly outflows above EUR1bn since January 2008 in European HY, and 21 greater than USD1bn in US HY. Three of these major outflows have happened in the last year in Europe and eight in the US, suggesting their frequency is increasing. Overall, AUM growth in Europe has softened the blow, with aggregate AUM reaching EUR74.9bn at end-January from EUR50.9bn at end-2013. But US HY fund AUM is in decline from a peak of USD311.5bn at end-2013 to USD236.7bn at end-2015. This will exacerbate the effect of large US outflows on the market as a whole, and on individual funds.

Some rated HY funds are taking steps to address liquidity risk. These include increasing cash balances to meet outflows and reducing position sizes to increase their ability to liquidate positions if they face a combination of redemptions and market stress. Some fund managers have implemented committed liquidity lines, but these are often dwarfed by the size of the related funds or fund managers. A more fundamental risk is the inherent structural liquidity mismatch. The vast majority of UCITS corporate credit funds offer daily liquidity, irrespective of whether they invest in the lowest-quality HY securities or the very highest investment-grade issuers.

January's outflows coincided with a slump in HY issuance due to fears about global growth and the effectiveness of QE for boosting inflation. European issuance to end-February fell 90% yoy, but we expect primary supply to pick up later in the year. The European market's mostly 'BB' composition results in a benign default rate outlook, but credit quality in the US market is weaker and there is a much higher energy-sector footprint. This combination leads to higher refinancing pressure than in Europe.