EPFR: Global junk funds show $8.8 billion net outflow in 2008 - but $1.7 billion year-end upturn

By Paul Deckelman

New York, Jan. 7 - Two-thousand-eight was "a brutal year" for both equity and fixed-income investment funds, and notably for junk bond funds, EPFR Global said Wednesday, with total global outflows from stock and bond funds tracked by the Cambridge, Mass.-based fund data reporting service adding up to some $321.4 billion.

Excluding exchange-traded funds, or ETFs - stock-like investment vehicles which can report inflows even in a down market, when they are aggressively purchased for lending on to short sellers - the total cash hemorrhage from the more conventional equity and bond funds stood at what the company called "a whopping" $475.8 billion at year-end. Of that amount, $8.813 billion of the outflows came from high-yield funds, a group primarily focused on the junk bond market in the United States, but also including funds domiciled in Europe or Asia, and those which invest in multiple geographic regions.

However, the silver lining for that very dark cloud, EPFR said, was that as 2008 drew to a merciful close, the junk funds mounted a stunning turnaround, tabulating $1.7 billion of net inflows over the last five straight weeks, mostly in the U.S. funds that make up the bulk of EPFR's junk bond tracking universe, and showing inflows in seven out of the last nine weeks of the year.

That comeback pushed the 2008 total for just those U.S. funds back into the black to the tune of $865 million - while the rest of the junk world ended the year in the red.

Junk funds end year with a bang

The year-end surge was especially pronounced over the last two weeks of 2008, according to EPFR's managing director, Brad Durham, who told Prospect News that he was "rather astonished" that the U.S. funds managed to finish the year on the plus side, since except for a brief springtime upturn, they had spent most of the year showing net outflows, just like their overseas counterparts.

But building on the inflow momentum which had begun in November and then moved on into December, the final week of the year saw net inflows to all of the high yield funds totaling $448 million globally, including $320 million, or about 71%, to the U.S. funds, while the week before, net inflows had totaled $807.89 million, including $753 million for the U.S. funds, or 93% of the total.

Durham said that the year-end surge marks "the first signs of investors taking on more risk in the high yield bond area - it's one of those telltale signals that investor risk appetite is returning."

While junk bonds are currently priced to reflect a 20%-plus default rate, he said, "the combination of better-quality credit dropping into the [junk] asset class because of ratings downgrades, the benefits of lower interest and fuel costs on key issuers, and a general hunger for yield are drawing fresh money into these funds."

He said that EPFR's fund-flow data over the last weeks of 2008 had "shown real stability, due to whatever year-end issues [have come into play], maybe looking forward to 2009; there's a growing amount of strategy work out there [from analysts and economists] showing there will be a recovery, maybe a strong recovery, in the second half of '09 and maybe investors are trying to anticipate that a little bit, so we've seen a stabilization in the flow activity" after the nearly year-long slide.

The flows were "really bad in the summer - but now things seem to be stabilizing quite a bit in recent weeks and that's been a very helpful signal."

The rebound in junk-fund inflows, particularly for mutual funds - which can be viewed as something of a barometer for overall high yield liquidity trends, since the flow of money into and out of those funds is more easily quantified than other sources of market cash like retail investment, insurance companies, pension funds and hedge funds - is also "consistent with some other fund groups, such as emerging market equities. There's also European equities, which have also recently seen some inflows that have been rather surprising. It's part of the same phenomenon - there's just [been] so much negativity out there," before the year-end upturn.

Hedge fund heyday halted

The well-publicized troubles experienced by hedge funds in 2007- 2008 - from the problems of two Bear Stearns-affiliated funds that essentially kicked off the subprime lending crisis, through the closing of several other funds amid last year's credit crunch, and to even the massive losses which several funds suffered in the Bernard Madoff Ponzi scheme scandal that surfaced late in the year - will likely lessen the role hedge funds will play going forward in the junk market and other investment spheres, Durham believes.

"I think a lot of these hedge funds that were focused on strategies that incorporated higher-yielding fixed income into their investment process [probably] are in trouble, and some of them are going away, and I think the negative flows from hedge funds in the second half of 2008 indicate that [for investors] the shine is certainly off the hedge fund vehicle."

He feels that a lot of the negative publicity the hedge operations got as these troubles mounted was probably unjustified.

"They're like a magnet for all of the negative vibes in the market," he said, because they are opaque to outsiders - the financial press sometimes uses the more sinister-sounding label 'secretive,' while focusing on the lack of regulatory oversight and highlighting the billions of dollars that some high-profile hedge-fund operators like George Soros, John Paulson and Edward Lampert had made in happier times.

"For the longest time, there's been the impression that they're all swashbuckling entities that are always by definition highest-risk vehicles, and I don't think it's fair, really. But it is what it is - wherever there's a lack of information, people have to find someone to blame for things that are beyond their explanation."

At any rate, he added, global hedge fund assets total around $2 trillion - a lot of money, to be sure, but still only a tiny fraction of the $57 trillion total of assets in the traditional global mutual fund industry, even taking into account whatever impact leverage has on those hedge assets - he says it's two-to-three times at the most - "so the hedge funds never really even came close to having command of the total assets as the traditional mutual funds have had," including unit trusts in the United Kingdom or SICAV funds in Luxembourg, and other similar mutual fund-type structures.

While perhaps influential "in specific types of trades," their overall influence on the junk market - which Durham called "overstated" - is "clearly diminishing and will continue to diminish." From the standpoint of one who routinely tracks money flows among various types of funds, the EPFR manager said that he is "hopeful that maybe the hedge fund influence is dissipating, since they're so hard to collect frequent fund-flow data from; we do track some hedge funds, but only to the extent that they fit snugly into our current fund groups."

Doing it by the numbers

The funds in EPFR's junk universe have total assets of approximately $116 billion, with the U.S. funds accounting for $86 billion of that, or 74%, versus $30 billion for the non-U.S. funds. Funds which report on a weekly basis had total assets of $53.2 billion, or 45% of the total -- $40.4 billion in U.S. funds and $12.8 billion in non-U.S. funds. Monthly-reporting funds accounted for the other $62.8 billion of the total assets, or 55%, with no geographic breakdown available. EPFR calculated its year-end fund flow numbers using monthly flow data, which includes both weekly and monthly reporters, for the January-November period and weekly flow data for December, with final flows data for monthly-only reporting funds for December to be available in mid-January.

EPFR's methodology, as well as its numbers, differ somewhat from the widely followed fund-flow statistics compiled by AMG Data Services of Arcata, Calif., which usually circulate in the junk market around or after the close most Thursdays. As the year was ended, market sources familiar with the latter data said that for the last reporting week of 2008, ended Tuesday, Dec. 30, weekly-reporting junk mutual funds - buoyed by the consecutive gains approaching the year-end and the very large inflows over the final two weeks of the year, showed a net inflow of almost $2.123 billion while the monthly reporters had cash infusions for the year of $2.726 billion, for an aggregate net inflow of nearly $4.849 billion.

Durham noted that unlike the domestic-oriented AMG numbers, EPFR's $8.8 billion global net outflow for the year was attributable to the impact of the non-U.S. funds, whose late-year upturn, such as it was, was considerably more restrained than that of their U.S. counterparts. While the U.S. funds managed to charge back into the black on a cumulative basis as the year was ending, full-year totals for all four of the other geographic categories which EPFR includes in its high-yield bond calculations - Western Europe, Europe Regional, International and Global - were all in the red. While the two European categories' cumulative outflows managed to come in at under $1 billion each, the International and Global categories - covering junk funds throughout the rest of the world - suffered far bigger cash exits.

Durham pointed out that as of Dec. 22, before the big surges in the year's two final reporting weeks, the overall global net junk fund outflow stood just a hair under $6 billion - with the non-U.S. funds responsible for at least $5.3 billion of that, or 88%.

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