With U.S. high-yield debt receiving ample attention from the mainstream media and within the financial blogosphere, it is not surprising that some investors may be overlooking international junk bonds as possible portfolio additions.
Ignorance, however, may not be bliss when it comes to European junk bonds. Helped by the Eurozone inching out of a deep recession, European high-yield bonds are poised to make October their best month since April, reports Katie Linsell for Bloomberg.
Fraser Lundie, co-head of credit at Hermes Fund Managers, told Bloomberg “European high-yield is in a sweet spot at the moment,” while noting junk bonds tend to outperform in slow growth environments, such as the one Europe is currently contending with.
That is potentially good news for the Market Vectors International High Yield Bond ETF (NYSEArca: IHY). IHY tracks the Bank of America Merrill Lynch Global ex-US Issuers High Yield Constrained Index (HXUS), which is comprised of junk bonds “denominated in Euros, U.S. dollars, Canadian dollars or pound sterling issued in the major domestic or Eurobond markets,” according to Market Vectors.
While IHY does offer a fair amount of emerging markets exposure (China, Russia and Brazil combine for 13.6% of the ETF’s weight), the ETF is more heavily allocated to developed markets. For example, the ETF’s top-five country weights are the U.K., France, Germany, Italy and Luxembourg. Those countries combine for 49.2% of IHY’s weight. [Junk Bond ETFs for Income]
Spain and Portugal, among other Eurozone nations are also found among IHY’s holdings.
Year-to-date, IHY has performed almost in line with the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG). HYG is up 5.2% while IHY is higher by 4.8%. The past 90 days tell a different story as IHY is breaking away from its U.S. rival with a gain of 4.9%, double HYG’s returns over the same time frame. [Junk Bond ETFs Love a no Tapering World]
Over the past year, IHY has outpaced HYG by 170 basis points while only being 40 basis points more volatile. IHY’s 30-day SEC yield of 5.17% is about 20 basis points higher than HYG’s.
Those are not the only reasons to consider European high-yield bonds. IHY’s effective duration of 3.57 years is slightly below the 4.06 years found on HYG.
European and emerging markets junk bonds also have lower default rates than U.S. equivalents. From 1981 to 2011, the average default rate on U.S. and tax haven high-yield corporate debt was 3.46%, according to Market Vectors. For Europe and emerging markets junk bonds, the default rates were 1.75% and 1.55%, respectively.
Market Vectors International High Yield Bond ETF