High-yield corporate bond ETFs are bouncing back after a rare three-day sell-off. Some investors are worried junk bond ETFs are overheated after such a strong run but they have endured the recent bump higher in Treasury yields quite well.
Junk debt ETFs slipped after Federal Reserve Chairman Ben Bernanke last week warned investors on the risks of stretching for yield in a low-rate market for bonds. [Junk Bond ETFs Lower After Bernanke Warns on ‘Reaching for Yield’]
The pullback triggered some outflows from the two largest junk bond ETFs. In the past week, investors have pulled $343.4 million from iShares iBoxx High Yield Corporate Bond (NYSEArca: HYG) and $291 million from SPDR Barclays High Yield Bond (NYSEArca: JNK), according to data from IndexUniverse. [High-Yield Bond ETFs Fall Amid Outflows]
HYG holds total assets of $15.9 billion while JNK holds $11.4 billion.
Other ETFs for the asset class include PIMCO 0-5 Year High Yield Corporate Bond Index Fund (NYSEArca: HYS), PowerShares High Yield Corporate Bond Portfolio (NYSEArca: PHB), SPDR Barclays Capital Short Term High Yield Bond (NYSEArca: SJNK), Peritus High Yield ETF (NYSEArca: HYLD) and First Trust High Yield Long/Short ETF (NasdaqGM: HYLS).
Next page: ‘Turning over every rock for yield’
“Investors have been turning over every rock they can find in the search for yield, causing the high-yield space to be booming as of late,” writes technical analyst Andrew Thrasher at his blog, noting that HYG and other high-yield bond ETFs are popular funds to get exposure to the sector.
HYG has seen bullish momentum and on balance volume in 2013, “a sign that buyers continue to step in to move prices higher,” he said.
The “frothy” junk market is actually yielding less than what 10-year Treasury notes were paying five years ago.
Investors have never been paid less to own high yield debt, according to Bespoke Investment Group.
“Yields are so low, in fact, that five years ago the yield on the 10-year U.S. Treasury was higher than the current yield on junk bonds,” according to Bespoke. “With yields this low, high-yield bonds are anything but high yielding.”
The largest junk bond ETFs are currently paying yields of less than 5%. However, the yield spread versus Treasuries isn’t exactly flashing an overvalued warning sign.
“The credit spread is actually high in comparison with other periods when [high-yield corporate] default rates were as low as they are currently, which is around 3%,” says Fran Rodilosso, fixed-income portfolio manager at Market Vectors ETFs.
Ryan Issakainen, ETF strategist at First Trust Advisors, points out that high-yield bonds are very sensitive to changes in credit conditions, but less sensitive to interest rates than U.S. Treasuries and investment-grade corporate bonds.
“This has important implications as the U.S. economy continues to strengthen, which will likely lead to rising interest rates in the future, resulting in falling bond prices,” he wrote in a recent report.
Higher interest rates often coincide with periods of relatively strong corporate fundamentals when credit spreads are decreasing. This can offset some of the negative impact that rising interest rates have on high-yield bond prices, Issakainen said.
iShares iBoxx High Yield Corporate Bond
Full disclosure: Tom Lydon’s clients own HYG and JNK.