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Thomas Kenny

Bank of America Sounds Another Alarm on Corporate Bonds

By February 6, 2013

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Worried about the bond market? If so, you're not alone - just about every day, a new expert weighs in with concerns about the potential impact of rising rates. Yesterday, it was Bank of America's turn at the plate. In a note to clients, the bank's corporate bonds strategists said that if yields on U.S. Treasuries rise too quickly, the corporate bond market could be in jeopardy.

It's no secret that corporates typically underperform when rates are rising rapidly, but the danger is even more severe now due to the substantial inflows of new cash into the asset class during the past year. CNBC, which has a full analysis of the BofA report here, reports that "corporate bonds are now 42 percent of mutual fund assets, compared to 24 percent in 1994 and 31 percent in 1999, while mutual funds and ETFs combine own nearly one-fifth of the entire corporate bond market, including high yield bonds." This means that individual investors have a greater influence on the asset class than ever before.

The concern that some of these assets will begin to leave bonds and rotate into stocks once bond returns begin to suffer - an event that's been dubbed "The Great Rotation." Says Hans Mikkelsen, a BofA corporate bond strategist quoted in the CNBC article, "If we were to experience outflows from bond funds of the magnitude seen in 1994 and 1999, the impact on corporate bonds this time would be much more severe. There is reason to suspect that households will play a more active role in rebalancing out of bonds, into stocks as interest rates increase."

Corporate bonds are off 1.4% so far in 2013, as measured by the iShares Investment Grade Corporate Bond ETF (ticker:LQD), as the yield on the 10-year Treasury has climbed from 1.76% to 2.02% (as its price has fallen .

Learn more: Is the Great Rotation a Legitimate Concern?

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