High-Yield Bond ETFs: Too Risky After Big Rally?

ETF Trends

After garnering a huge following among yield-starved investors, speculative-grade corporate bond exchange traded funds have been weakening since January and are now testing their short-term trends.

Meanwhile, Moody’s warns that junk bond covenant quality fell to an all-time low in January, reports Micheal Aneiro at Barron’s.

Moody’s says investors are not being adequately compensated for accepting these weaker covenants. “While investors are taking on more covenant risk, average spreads to benchmark yields have tightened, fueled by strong demand and a record volume of issuance,” Moody’s notes, according to the Barron’s report.

The iShares iBoxx $ High Yield Corporate Bond Fund (HYG) and the SPDR Barclays High Yield Bond ETF (JNK) are hovering around their 50-day moving averages. The last time the two funds tested their short-term averages was in November 2012.

If the funds break through the 50-day average, investors may expect to see the investments test their long-term trends around the 200-day average.

“The junk-bond market registered the economic upturn early, provided the juiciest returns as easy money floated through world markets and has led the stock market step by step to its recent five-year highs,” writes Michael Santoli for Yahoo Finance.

“In recent years, junk represented the best of both worlds, benefiting from easy liquidity, delivering a nice yield premium in an income-starved world and offering an ‘equity-like’ bonus return thanks to their leverage to reviving economic conditions,” he notes. “Now, though, with yields around 6%, high yield bonds look decidedly bond-like and fully priced.”

We’ve been highlighting the recent correction in high-yield bond ETFs and what it could portend for the stock market. [High-Yield Bond ETF Pullback a Warning Signal for Equity Bulls?]

With the Federal Reserve keeping short-term interest rates near zero, investors have been branching out to more attractive yield generating assets, like junk bonds. Consequently, yields on speculative debt are as low as they have ever been.

JNK and HYG are yielding around 5%.

While spreads between high-yield debt and Treasuries have shrunk, David Sherman, founder of Cohanzick Management, believes that high yield debt will perform better than other fixed-income assets in a rising rate environment, reports Joy Ferguson for Reuters.

“Even though junk-bond yields are at historic lows, the spread over central bank manipulated Treasuries is reasonable and should provide some cushion in a rising rate environment,” Sherman said in the article.

iShares iBoxx $ High Yield Corporate Bond Fund

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For more information on speculative grade debt, visit our junk bonds category.

Max Chen contributed to this article.

Full disclosure: Tom Lydon’s clients own JNK and HYG.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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