Investors in popular high-yield bond and preferred stock ETFs can’t say they weren’t warned.
On May 10, Federal Reserve Chairman Ben Bernanke said the central bank was keeping close tabs on signs investors were taking on more risk to generate income with interest rates so low.
“In light of the current low interest rate environment, we are watching particularly closely for instances of ‘reaching for yield’ and other forms of excessive risk-taking, which may affect asset prices and their relationships with fundamentals,” Bernanke said. [Junk Bond ETFs Lower After Bernanke Warns on ‘Reaching for Yield’]
That May speech coincided with a top in ETFs tracking corporate junk bonds and preferred shares. Since then, the funds have seen their year-to-date gains wiped out, and then some.
For example, SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) is off 2.5% so far in 2013 and iShares U.S. Preferred Stock ETF (NYSEArca: PFF) is down 1.8%, according to Morningstar. The recent sell-off as Treasury yields surge has resulted in losses of about 6% over the past month for both funds. The ETFs have also dropped below their 200-day moving averages.
Indeed, the spike in interest rates illustrates the dangers of investors stretching for more income. Yields on the 10-year Treasury note have jumped from about 1.7% to around 2.6% in under two months. Investors for years have been warned to prepare for higher rates, but the velocity of the move has caught many off guard. The Fed has indicated it may pull back from its monetary easing if the economy continues to recover.
ETFs indexed to preferred stock and high-yield bonds have been a favorite among income-seeking investors the past few years in a low-rate environment. Performance chasers who bought in this year are now sitting on losses, however.
PFF, the preferred share ETF, is currently paying a 30-day SEC yield of 5.3%, while the high-yield fund JNK pays 5.6%.
Earlier this year, demand for junk bond ETFs pushed yields under 5% for the first time. [Junk Bond ETF Yields May Fall Below 5% Amid Scramble for Income]
SPDR Barclays High Yield Bond ETF
The opinions and forecasts expressed herein are solely those of John Spence, 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.