Investors stretching for yield have piled into corporate bond ETFs, particularly high-yield debt funds. Income-starved investors buying large amounts of junk bonds has pushed yields down sharply and triggered worries of a bubble in this hot sector.
High-yield bond funds have seen record inflows of $43 billion so far this year, Barron’s reports.
Investors are taking on more risk in their search for yield with interest rates at rock bottom. Money market funds are essentially yielding zero. [Investors Chase Yield, Risk in Junk Bond ETFs]
The frenzy of buying in speculative-grade debt has driven bond prices and yields near record levels. However, some analysts are worried investors could get burned if defaults start to pick up.
Nominal junk yields are “already way below where they deserve to be,” Stephanie Pomboy, founder of MacroMavens, said in the Barron’s report. “The very folks driving the bubble’s inflation — those most desperate for yield — pension funds, insurance companies, and retail investors, will be hit the hardest.”
Junk bond ETFs have been big sellers in 2012. Through the end of July, the iShares iBoxx High Yield Corporate Bond (NYSEArca: HYG) gathered inflows of $4.7 billion year to date. SPDR Barclays Capital High Yield Bond (NYSEArca: JNK) has taken in $2.3 billion.
“Corporate bonds are denoted high yield for the sole reason that firms issuing them are highly leveraged,” Morningstar analyst Timothy Strauts writes in profile of JNK. “With increased leverage comes the increased probability of default and bankruptcy. In the grand scheme of things, risk equals return, and the high yield of these bonds is designed to compensate investors for this risk.”
Companies are rushing to sell speculative-grade debt, and investors keep snapping it up.
“With interest rates being so low for so long, yield-starved investors have been increasingly willing to risk their money on junk bonds in order to get that extra yield,” writes Christopher Matthews for Time magazine. “And as new money starts pouring into high-yield bonds, some are starting to worry that the junk bond market has reached bubble-like levels.”
iShares iBoxx High Yield Corporate Bond
Full disclosure: Tom Lydon’s clients own JNK and HYG.