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Size Matters With Junk Bond ETFs

ETF Professor

The iShares iBoxx $ High Yid Corp Bond (ETF) (NYSE: HYG) and the SPDR Barclays Capital High Yield Bnd ETF (NYSE: JNK), the two largest high-yield corporate bond exchange-traded funds, along with other junk bond ETFs endured plenty of controversy last year. If flows data are any indication, investors are not convinced 2016 will bring better things for junk bond ETFs. Add to that, HYG and JNK are two of the 10 worst ETFs in terms of year-to-date outflows.

Amid a spate of energy issuer defaults and downbeat performances by CCC-rated issues, tensions are running high in the U.S. junk bond market. Juxtapose this with the fact that ETFs such as HYG and JNK have been plagued by an abundance of issues from the downtrodden energy and materials sectors. Those groups accounted for the bulk of high-yield defaults last year.

Related Link: Junk Bonds Are Outperforming Stocks

How Important Is Size Really?

Some investors remain concerned about junk bond liquidity, indicating that size is a concern as well. Home to a combined $22.2 billion in assets under management, HYG and JNK certainly pass the size test, but what is more important is the size and subsequent liquidity of the ETFs' underlying holdings. A recent study by Fitch Ratings confirms that an issue's size and ratings were pivotal factors in determining junk bond liquidity.

“Fitch's analysis of the bonds held by ETFs found that bond issue size and credit quality strongly influenced how often they were traded. Fitch analyzed the trading frequency of 1800 bond issues held by the 24 US-based high-yield bond ETFs from January 2, 2015 to December 15, 2015 as a proxy for the overall high-yield bond market. The ETFs had combined assets of approximately $34 billion, according to Bloomberg data. Issues that were not FINRA TRACE eligible were excluded from the study,” said Fitch Ratings in a statement.

When junk bond ETF volume soared in December, the secondary market efficiently absorbed increased turnover in HYG. The secondary market for junk bonds and ETFs like HYG is vital because during times of heightened market stress, over-the-counter high-yield bond market liquidity can and does evaporate, forcing the bulk of trading into the largest, most liquid issues.

"Larger issues with higher credit quality traded more frequently, while smaller, lower quality issues traded less. For example: 'CCC+' and lower rated issues between $250 million to $500 million traded on approximately 50 percent of the trading days in 2015. 'BB-'and higher rated issues with an issue size greater than $1 billion traded on almost 90 percent of these days. To put this activity in context, relative to the 2008-2009 period, 2015 was largely marked by moderate volatility and an absence of major liquidity disruptions,” added Fitch.

JNK allocates nearly 15 percent of its weight to bonds rated CCC or lower. HYG devotes 9.4 percent to CCC-rated bonds.

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