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What's Up With Junk Bond ETFs?

ETF Professor

The iShares iBoxx $ High Yield Corporate Bond ETF (NYSE: HYG), the largest high-yield corporate bond exchange traded fund by assets, is lower by about half a percent this month, but amid the intensifying trade imbroglio between the U.S. and China, things could be worse for HYG and rival junk bond funds.

What Happened

As a riskier asset class, it's not surprising the trade war is pinching HYG and high-yield bonds. Geopolitical events, including trade spats, have a way of prompting investors to seek safer assets, such as high-grade government debt, explaining why spreads on global junk bonds and comparable government bond spreads recently widened.

“High yield bond spreads – the difference in yields between high yield bonds and comparative government bonds – have widened, as perceived safe havens outperformed,” said BlackRock in a recent note. “These moves come amid a longer-term widening trend in credit spreads over the past couple of years.”

Predictably, investors have been skittish with junk ETFs. Month to date, the two largest junk bond ETFs, including HYG, have seen about $1.5 billion in combined outflows.

Why It's Important

While the business cycle is in its latter stages, potentially presenting headwinds for riskier assets, there are still some reasons to consider high-yield corporate debt.

“We see reasons to like U.S. high yield,” said BlackRock. “First-quarter corporate earnings results pointed to healthier fundamentals in high yield issuers. These include signs of declining gross leverage and near-record high levels of interest coverage – a measure of issuers’ ability to service their debt.”

The asset manager also cites improving index credit quality and a move away from highly speculative CCC-rated debt.

“In addition, the longer-term credit quality of the index has improved,” according to BlackRock. “Evidence includes a shift in issuance toward higher quality (less CCC-rated bonds), shorter maturities and larger individual issues.”

What's Next

The $15.83 billion HYG has a 30-day SEC yield of 5.54 percent and an effective duration of 3.42 years. HYG devotes 10 percent of its weight to CCC-rated bonds. Bonds with a BB rating account for almost 51 percent of the fund's roster.

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