Junk Bonds, ETFs See Default Rates Drop to 2008 Low

April 17th at 8:15am by Tom Lydon

While fixed-income assets are subject to rate risks, junk bond exchange traded fund investors also have to monitor credit risks, but now default rates on speculative grade debt have dropped to a six-year low.

According to Moody’s Investor Service, default rate among junk-bond U.S. companies fell to 1.7% at the end of the first quarter, the lowest since February 2008, from 2.2% in the fourth quarter of 2013, reports Michael Aneiro for Barron’s.

The current default rate is well below the historical default rate for high-yield bonds, which averaged 4.5% since 1993, according to Moody’s data. Moody’s, though, warns that default rates could rise to 2.4% by the end of the year and 2.7% in 2015.

The capital markets “continue to be open for low-rated companies, supporting a low default rate,” Moody’s said.

As a result of the Fed’s record low rate policies, most junk-rated companies have been able to refinance old debt, extend maturities and lower borrowing costs.

Nevertheless, speculative grade, junk bonds are one of the riskier assets in the fixed-income space.

“Investors should bear in mind that high-yield bonds are one of the most volatile sectors of the fixed-income market,” according to Morningstar analyst John Gabriel. “In many cases, issuers are classified as high-yield due to relatively high levels of financial leverage. This means that the risk of default is elevated, as (even for high-quality businesses) financial leverage decreases a firm’s margin of safety.”

The ultra-low default rates have helped attract greater investment interest in the junk bond market that yields an average 5.2%. The benchmark Bank of America Merrill Lynch Index has gained 3.3% so far this year. [A Revival in Corporate Bonds, ETFs]

The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the two largest junk-bond related ETFs, have gained 2.9% and 3.2% year-to-date, respectively.

HYG has a 4.48% 30-day SEC yield. The ETF has a small 6.6% allocation to BBB-rated, low investment grade quality bonds. The rest of its portfolio is allocated to speculative grade BB 45.9%, B 26.5%, CCC 10.7%, not rated 3.1% and other securities 6.9%.

JNK has a 4.81% 30-day SEC yield. The fund includes a lower 0.9% weight toward investment grade BBB-rated bonds, along with BB 38.8%, B 41.3% and CCC or lower 19.0%.

For more information on speculative grade debt, visit our junk bonds category.

Max Chen contributed to this article.

Full disclosure: Tom Lydon’s clients own shares of HYG and JNK.

The opinions and forecasts expressed herein are solely those of Tom Lydon, 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.

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