Junk Bond ETFs Surviving and Thriving Again

ETF Trends

High-yield bonds and the major ETFs that hold them “fell out of bed” following the release of the Federal Open Market Committee meeting minutes on May 22. The subsequent rise in yields on 10-year Treasurys highlighted the fact that junk bond ETFs, usually perceived to be vulnerable to credit risk, can also be stung by interest rate risk.

From May 23 to June 25, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) , the largest high-yield bond ETF by assets, fell 4.8%. The rival SPDR Barclays Junk Bond ETF (JNK) dropped 5.3%. [Bank Loan or Junk Bond ETFs for High Yields?]

Things have been noticeably different for HYG and JNK this month as investors are seen once again pouring cash into junk bond funds. HYG has hauled in $1.1 billion in investments this month while JNK has raked in nearly $325 million, according to Index Universe data. Both ETFs have gained more than 3.4% since the start of the month as investors’ fear about Fed tapering have ebbed.

“However, as fears have abated, High Yield has outperformed,” according to a new Citigroup research note. “We believe that this may be related to investor perception of the asset class as the preferred ‘risk on/risk off’ vehicle within Fixed Income.”

The race back into junk bond ETFs comes after the HYG and JNK shed assets at a startling rate following the May 22 FOMC announcement. From May 22 to June 24, HYG and JNK lost a combined $2.7 billion in assets, according to Citi. Although Fed Chairman Ben Bernanke’s recent comments about monetary policy remaining accommodating for the near future have pushed yields on junk bonds lower, some income investors are finding value in these ETFs. [Investors Jumping Back Into Junk Bond ETFs]

Bernanke’s reiteration that monetary policy will remain relaxed for the foreseeable future has also helped tighten spreads between junk debt and Treasurys. Wide spreads between high-yield bonds and U.S. government debt can be a signal that investors are concerned about credit risk. Narrowing spreads indicate investors believe the issuers of high-yield are faring better in an improving economy and default risk is decreasing.

Some investors may still be skittish about high-yield bond ETFs after the funds faced intense scrutiny for increased volatility and wide separations from net asset value during the May/June sell-off. Citi said the volatility of premiums and discounts in junk bond ETFs during times of stressed selling is attributable to “a combination of stale marks in the underlying holdings and arbitrage activity by authorized participants.”

Still, Citi views junk bond ETFs such as HYG and JNK as “structurally sound.” The bank said these funds operated as expected during a tumultuous period, trading continuously while providing liquid exposure to the high-yield bond market. Investors seem to agree as HYG and JNK currently trade an average of just 1.7% below their 52-week highs.

iShares iBoxx $ High Yield Corporate Bond ETF

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HYG

ETF Trends editorial team contributed to this article. Tom Lydon’s clients own shares of HYG and JNK.

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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