Investors Seek Riskier Debt, Jump into Junk Bond ETFs

ETFtrends.com
May 20, 2014

Speculative-grade, or so-called junk bond exchange traded funds are attracting more attention as investors turn to the riskiest corporate debt, with default rates depressed and low interest rates on safer assets.

Investors have picked up triple-C rated corporate debt – bonds that are considered highly speculative in nature, pushing down yields to 8.187% on the Bank of America Merrill Lynch Index, the lowest level on record, the Wall Street Journal reports.

“What we’re seeing is the continued search for yield,” Matthew Rubin, director of investment strategy at Neuberger Berman, said in the article.

The largest junk-bond ETFs, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and SPDR Barclays High Yield Bond ETF (JNK) , come with a 4.36% 30-day SEC yield and a 4.74% 30-day SEC yield, respectively. HYG’s credit quality includes BBB 4.8%, BB 48.5%, B 27.4% and CCC or lower 19.2%. JNK includes BBB 0.2%, BB 39.3%, B 42.3% and CCC or lower 18.1%.

Alternatively, the iShares B – Ca Rated Corporate Bond ETF (QLTC) specifically targets low-rated debt, including BB 16.6%, B 45.6% and CCC or lower 37.8%. The ETF has a 4.78% 30-day SEC yield.

The benchmark 10-year Treasury bond yields recently dipped below 2.5%, steadily declining this year from 3% at the end of 2013.

The low-rate environment “is forcing folks into riskier strategies in which they feel they will be more richly compensated,” Ford O’Neil, manager at Fidelity Total Bond fund, said in the article.

The yield gap between junk bonds and U.S. Treasuries has narrowed, with the difference between Treasury yields and CCC-rated debt at 6.97 percentage points, the lowest since November 2007.

Additionally, the market is positioning on a dampened expectation for Federal Reserve interest rate hikes. Many traders are also betting that while the economy is just stumbling along, the market is unlikely to fall into a recession that would trigger widespread defaults.

According to Standard & Poor’s Ratings Service, default rates on low-rated corporate borrowers was 1.7% in April, slightly higher than the six-month low of 1.57% in march.

However, Kathleen Gaffney, portfolio manager at Eaton Vance, warned that junk debt investors could be stockpiling future risk, as rates have to rise eventually and pressure bond prices.

Investors, though, have been fleeing some longer duration high-yield bond exchange traded funds in favor of junk ETFs with less sensitivity to rising rates. The PIMCO 0-5 Year High Yield Corporate Bond (HYS) has pulled more than $1.2 billion while the SPDR Barclays Short Term High Yield Bond ETF (SJNK) has raked in over $1 billion this year. HYS has a 2.92% 30-day SEC yield and a 1.92 year effective duration. SJNK has a 3.8% 30-day SEC yield and a 2.16 year effective duration. [Short Duration Junk Bond ETFs in the Limelight]

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

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