Big-Money Funds Are Betting Against Credit While ETF Shorts Build

Money managers including Loomis Sayles and Legal & General think US corporate bonds look so expensive that they’re cutting back on their holdings and in some cases even betting against the market.

(Bloomberg) — Money managers including Loomis Sayles and Legal & General think US corporate bonds look so expensive that they’re cutting back on their holdings and in some cases even betting against the market. 

Risk premiums, or spreads, on US investment-grade corporate bonds were just 1.24 percentage point as of Friday. That’s in line with the average of the last decade, but there’s a key difference now: an era of easy money has turned into a period of tight money. Financing costs are at their highest levels since the financial crisis, and corporate bankruptcies have climbed by about 40% this year. 

Peter Palfrey, a portfolio manager at Loomis Sayles, thinks spreads should be wider now. He and his team have been reducing exposure to credit overall in their Core Plus Fixed Income fund and currently have their biggest investment-grade underweight relative to their benchmarks since 2008. For high-yield bonds, they’re the most underweight since 2019 — which was their biggest underweight on record. Other investors are also bearish, and short interest in some of the biggest exchange-traded funds for corporate debt is jumping.  

“We just don’t think you’re being adequately compensated for being in credit securities,” said Palfrey, whose firm managed $303 billion as of the end of September. “The Fed has now tightened by 525 basis points. That puts a tremendous pressure on all risk markets, but on credit in particular.”

The market’s doubts about relative valuations underscore how difficult it is to determine fair prices for securities when interest rates have surged so quickly. Many of the investors buying corporate bonds now are paying little attention to relative valuation and are focusing instead on the high yields available. The average investment-grade corporate bond yield now was 6.1% as of Friday, compared with a 3.38% average for the last decade. Earlier this month, the yield reached its highest level since 2009.  

But at least some traders think valuations are too high, and are boosting their bets against major exchange-traded funds for corporate bonds. The number of shares sold short in the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) has spiked by more than 50% since mid-June, reaching a near-record of $7.2 billion, according to S3 Partners, a technology and data analytics firm. Short sales of the iShares iBoxx High Yield Corporate Bond ETF (HYG) have similarly climbed to nearly $7 billion.  

Alarmed investors are also pulling money out of funds, with high-yield bond funds seeing six weeks of consecutive outflows. That amounts to nearly $10 billion of cash being taken out of such funds for that period, according to Bank of America Corp., citing EPFR Global data. At the end of September, investment-grade funds saw their biggest weekly outflow since March.

John Roe, the head of multi-asset funds at Legal & General, is at his most underweight for US investment grade corporate bonds in more than five years. He’s also below benchmark levels for junk bonds. Legal & General manages $1.4 trillion of assets. 

“The market is pricing a very low risk of a significant recession now,” said Roe. “There’s limited upside given these spreads, but with the potentially large gain on the short position in an extreme outcome.”

Labor markets have remained strong, with non-farm payrolls increasing 336,000 in October, the most since the start of the year, a report earlier this month said. And households seem to have more excess savings than many economists had previously thought.  

But there are economic risks as well. The resumption of US student loan payments could hit consumer spending. With tighter money, small businesses are growing more pessimistic. And corporate bankruptcy filing activity has risen by more than 40% this year, according to a Bloomberg index that measures both the number and size of filings for companies with at least $50 million of liabilities. 

Michael Anderson, a Citigroup high-yield strategist, has just flipped his overweight recommendation for long duration junk bonds to underweight citing pressure from rising real yields and too complacent spreads.

“We are starting to see some macro warning signs,” Anderson said. “As the Treasury is borrowing a lot, the Fed is conducting quantitative tightening shrinking its balance sheet. Real yields moving higher is a sign of tightening financial conditions.”

More stories like this are available on

©2023 Bloomberg L.P.