Junk bond ETFs such as SPDR Barclays High Yield Bond (NYSEArca: JNK) are trying to break out to their highest levels since the financial crisis. However, there are lingering fears about credit and interest-rate risks in high-yield debt ETFs, with some analysts saying it’s mathematically impossible for the funds to increase much further in price.
Junk bond ETFs are paying 5% or more in yield, which has caught the attention of income seeking investors. Despite talks of a bond bubble and rising rates, investors have continued to put more assets into junk bond ETFs. [High Yield Bond ETFs: Too Risky After Big Rally?]
“But junk bond investors beware–the situation is likely to change this year. The minutes of the FOMC meeting released yesterday suggest that many members are concerned about the potential risks of continued asset purchases by the Fed. As a result, the Fed may slow-down its asset purchases earlier than previously thought. If the rates start to rise, the bond market rally will finally come to an end. The ten-year note has already broken the psychological barrier of 2% this year. Within the fixed income space, junk bonds appear to be at highest risk,” Neena Mishra wrote for Zacks. [High Yield Bond ETFs Can’t Shake Bubble Talk]
The relative lack of liquidity in the junk bond market has critics warning that a reversal in this sector could be a quick event, should interest rates start to rise. Furthermore, the spread between the S&P 500 earnings yield and junk bonds is getting expensive. [Vanguard Demurs on High Yield Bond ETFs]
“While junk bonds are keeping investors happy by churning out strong returns, they face renewed pressures in the form of rising interest-rate risk and a quirk of bond math that almost guarantees price losses over time for high-yield exchange-traded funds,” writes Michael Aneiro at Barron’s. “Like dividend-paying stocks that drop in value after their ex-dividend date, bond ETFs tend to gradually rise in price each month as the coupon payment accrues and then shed those gains when it’s paid.”
Peter Tchir of TF Market Advisors says price moves are growing distorted and that investors have been propping up the long-term core price of these ETFs at levels that—according to math that governs the underlying bonds—are unsustainable, according to the Barron’s story.
Nevertheless, investors are still favoring the high-yield junk bond category at the moment as defaults remain relatively low and the ETF allows for easy, diversified exposure to this area of fixed income.
Corporate bonds now comprise 11.7% of all the assets held by ETFs, up from 7.5% at the end of 2010, WSJ.com’s MarketBeat blog reports.
- iShares iBoxx $ High Yield Corporate Bond (NYSEArca: HYG) yield 6.55%
- SPDR Barclays High Yield Bond (NYSEArca: JNK) yield 6.72%
- SPDR BarCap Short Term High Yield Bond ETF (NYSEArca: SJNK) yield 5.73%
- PIMCO 0-5 Year High Yield Corporate Bond Index (NYSEArca: HYS) yield 5.33%
SPDR Barclays High Yield Bond
Tisha Guerrero contributed to this article.
Full disclosure: Tom Lydon’s clients own HYG and JNK.