High-yield ETFs that invest in speculative-grade corporate debt have raked in cash in 2012 and risen to one-year highs. However, a spike in defaults last month is a reminder of the sector’s risks.
The spread or yield differential between high-yield bonds and Treasuries continues to narrow as investors take on more risk, according to BondSquawk.
The iShares iBoxx High Yield Corporate Bond (NYSEArca: HYG) and SPDR Barclays Capital High Yield Bond (NYSEArca: JNK) have posted total returns of more than 8% year to date. They are both offering 30-day SEC yields of around 6%. [Are High-Yield Bond ETFs in a Bubble?]
“Despite the stellar outperformance, the fundamentals are painting a different picture as default activity in August was high,” BondSquawk reports. “August was an active month as four High Yield companies defaulted totaling $2.14 billion. This surge in defaults surpasses July’s volume as only two companies defaulted totaling $381.8 million while no High Yield companies defaulted in June.” [PIMCO High-Yield Bond ETF]
High-yield ETFs have been big sellers all year. For example, in just the last month, JNK has pulled in $366 million, according to XTF.
However, higher yields come with higher risks.
“We consider investing in high-yield corporate bonds to be similar to investing in the equities of companies with highly leveraged balance sheets,” says Morningstar analyst Timothy Strauts.
“Corporate bonds are denoted high yield for the sole reason that firms issuing them are highly leveraged,” he added. “With increased leverage comes the increased probability of default and bankruptcy.”
SPDR Barclays Capital High Yield Bond
Full disclosure: Tom Lydon’s clients own HYG and JNK.