Although investment-grade bonds have performed better recently, we expect high-yield bonds to hold their value better in the medium term as rates rise and the economy continues to grow.
David Sekera: Since returns are more closely correlated with Treasury rates in the investment-grade sector than in the high-yield sector, as the Treasury market rallied this year and yields have come down, we've actually seen the investment-grade bond sector outperform that of the high-yield sector. So, thus far this year, the Morningstar Corporate Bond Index, which is our proxy for the investment-grade sector, has risen over 6.5%, whereas the Bank of America Merrill Lynch High Yield Index has only risen 5.8%.
In the Treasury market in the 10-year space and with longer rates, we've actually seen yields come down. So, for example, for the 10-year, it's actually now down to 2.4%, about 60 basis points lower than where it ended last year. That 60 basis points well overshadows the 12 basis points of credit-spread tightening that we've seen in the investment-grade space.
Now, in the high-yield space, the Merrill Index has actually decreased about 20 basis points--it was actually even lower and tighter earlier this year. So, at the end of June, it had decreased a total of 45 basis points. Currently, it stands at 380 basis points.
In July, we actually saw significant redemptions come out of the high-yield space in mutual funds and ETFs, so actually the cumulative total for the four weeks for the week ending Aug. 6, we had actually seen over $12 billion of redemption within the high-yield sector. As such, those portfolio managers had to sell bonds in order to cover those redemptions.
In the three week since then, we've actually seen fund flows return and are positive again, but they haven't returned to such a degree that we pushed spreads back down to the lowest rates that we saw at the end of June.
For the second half of this year, we do expect the United States economy to continue to grow at the pace that we're currently seeing right now. We also expect that the Federal Reserve will discontinue and end its asset-purchase program this fall. As such, we do think that over the medium-term interest rates will start to rise.
Now, with interest rates rising, but yet the economy still holding in and default rates will be kept low because of the expansion in economic growth, we do think that the high-yield sector should outperform and hold its value better than the investment-grade sector going forward.
