The sell-off in speculative-grade junk bonds and related exchange traded funds may be over done as retail investors jumped ship despite strong fundamentals.
Over the past month, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) declined 1.8% while the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) fell 2.0% on significant outflows over July. [Junk Bond ETFs Crimped by Outflows]
Bank of America Merrill Lynch’s head of high yield strategy, Michael Contopoulos, points out that spooked retail investors exited the space but argues that concerns over junk bonds are unfounded, CNBC reports. [Rising Volatility Hits Risky Junk Bond ETFs]
“What we’ve seen in high yield has really been a retail-driven story,” Contopoulos said on CNBC. “There’s been a confluence of events, between geopolitical, Fed and media coming out and talking about a leverage finance bubble, and the easing of lending standards, that have instituted some fear in the retail crowd. You couple that with valuations that were very, very rich at the end of the second quarter—I think that’s really led to a little bit of retail panic, if you will, although that has subsided over the last few days.”
Since the August 1 low, JNK is up 1.1% and HYG is up 1.5%.
Contopoulos believes the high-yield bond market will continue to “rebound pretty well,” citing strong fundamentals that support the asset class. Specifically, the credit risk is very low and Bank of America Merrill Lynch does not anticipate defaults over the next couple of years.
“If you look at interest coverage, which is probably the single most important metric in the high-yield market—so the ability of a firm to ultimately make the interest payment on its debt through earnings—it’s at all-time-high levels,” Contopoulos said. “And this is why companies default, because they can’t pay interest expense.”
Nevertheless, investors should keep in mind that junk bonds are still riskier than investment-grade securities. For instance, JNK’s fund quality includes speculative grade BB 36.4%, B 43.9% and CCC or lower 18.9%. HYG’s credit quality breakdown includes BB 49.6%, B 28.8% and CCC or lower 18.4%.
For more information on the speculative-grade debt market, visit our junk bonds category.
Max Chen contributed to this article.
Full disclosure, Tom Lydon’s clients own shares of HYG and JNK.