In the ongoing search for yield, investors have been piling into high-yield, junk bond exchange traded funds. However, investors need to clearly understand the risks of ETFs that hold lower-quality corporate bonds.
PIMCO Total Return ETF (NYSEArca: TRXT) manager Bill Gross in a recent interview said investors should be careful with high-yield bonds. Defaults in the sector are low due to the Federal Reserve’s quantitative easing, but if the U.S. economy falters, defaults could rise, he said. Total Return ETF can buy high-yield bonds but doesn’t own many of them, he added.
Year-to-date, junk bond mutual funds and ETFs have garnered over $17 billion in new assets, reports Jason Zweig for The Wall Street Journal. Meanwhile junk-bond prices have increased 5% so far this year as investors jumped at the asset class.
The iShares iBoxx High Yield Corp Bond Fund ETF (NYSEArca: HYG) and the SPDR Barclays Capital High Yield Bond ETF (NYSEArca: JNK) have brought in $5.7 billion between the two, or a 34% rise in assets under management since the end of 2011. [ETF Spotlight: High-Yield Bonds]
However, some analysts caution that the boom in junk-bond ETFs is creating potential risks. For instance, the bond holdings in high-yield ETFs are behaving or pricing differently from comparable bonds not included in the underlying benchmark indices. The analysts are noting that the ETFs are beginning to influence the behavior of the underlying high-yield bonds.
“ETFs have their costs and their benefits,” Oleg Melentyev, head of high-yield corporate strategy at Bank of America Merrill Lynch, said in the report. “And this is one of their costs.”
However, the providers contend that the funds aren’t influencing the market.