High-yield corporate bonds are one of the biggest stories in 2012 for the ETF business.
First, investors scratching for yield have been piling into ETFs that invest in non-investment-grade or “junk” bonds.
Also, a big trade in a junk bond ETF this month has some wondering if big investors will use ETFs more to avoid trading in the secondary market. There are also questions about how this activity could impact long-term investors in these ETFs. [Will More Big Investors Use ETFs to Disguise Trades?]
“Corporate bonds are denoted as ‘high yield’ for the sole reason that firms issuing them are highly leveraged. Companies with this kind of leverage profile can get there either intentionally, as the result of a leveraged buyout, leveraged acquisition or recapitalization, or unintentionally because of a deterioration of the underlying business of an erstwhile investment-grade firm,” John Gabriel wrote in a Morningstar analyst report.
The high yield of these funds reflects the higher risk of investing in speculative grade paper. Furthermore, yields are usually best viewed in relation to what Treasury bonds are doing, and the resulting difference is known as the credit spread, reports Gabriel. [Bond ETF Assets Rise 40% in a Year]
Currently, the yield on a 10-year Treasury bond is just under 2%, a key driver for the push into corporate, high-yield bonds.
Junk bond ETFs have been an answer to investors who are seeking yield and stability. [ETF Chart of the Day: High Yield Corporate Bonds]
- SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) This ETF holds a portfolio of over 200 publicly issued U.S. dollar-denominated, non-investment grade, fixed-rate, taxable corporate bonds
- iShares iBoxx High Yield Corporate Bond Fund (NYSEArca: HYG) This fund offers even broader exposure to the “junk bond” universe, offering a portfolio of nearly 600 U.S. dollar-denominated debt securities.
- PowerShares Fundamental High Yield Corporate Bond Portfolio (NYSEArca: PHB) This offering differs from comparable junk bond ETFs by determining it’s underlying portfolio allocations based on a host of fundamental factors; the traditional market cap-weighted approach simply gives the greatest weight to the biggest debtor. [High Yield Corporate Bonds]
Tisha Guerrero contributed to this article.
Full disclosure: Tom Lydon’s clients own HYG.