Junk Bond ETFs Look Attractive After the Bloodletting

Investors are snatching up speculative-grade, high-yield bond exchange traded funds on the cheap after the sell-off pushed spreads over benchmark Treasuries close to historical averages.

Through the first half of October, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) fell 1.7% while the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) declined 2.8%. Over the pas week, HYG gained 3.0% and JNK increased 2.7%.

“The bubble in ‘junk’ bonds appears to be deflating,” John Higgins, an analyst at Capital Economics, said, CNBC reports. “The spread over Treasurys of BBB-rated, 7-10 year bonds is currently close to its average of the past quarter of a century – the same could not be said, at least until recently, for the spreads of bonds lower down the credit rung.”

In June, the spread between B-rated bonds and Treasuries tightened to 320 basis points, or 200 basis points below its 25-year average. Now, the spread has widened back to about 430 basis points.

After the recent selling, bond yields have inched higher – bond prices and yields have an inverse relationship. HYG currently shows a 5.16% 30-day SEC yield and JNK has a 5.81% 30-day SEC yield. Now that yields are higher, some argue that it is a good entry point back into the junk debt market. [Ideas for a new World for Bonds]

“We now see risk/reward as more attractive than it has been in over a year,” Morgan Stanley said in a note, recommending overweighting the sector and moving down the rating spectrum from BB-rated paper into B- and CCC-rated paper. “High-yield is not only cheap in absolute terms for the first time in over a year, but it is now particularly attractive relative to most other asset classes.”