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.”
Over the past week, investors have moving back into junk bond ETFs. For instance, the PowerShares Fundamental High Yield Corporate Bond ETF (NYSEArca: PHB), which has a 4.4% 30-day SEC yield, has attracted $3.8 million in assets over the past week, whereas it has experienced $59.1 million in outflows over the past 30 days, according to PowerShares data. [Fixed-Income Traders Increasingly Rely on Junk Bond ETFs]
Rising yields may also signal risk in the speculative-grade debt market. However, default rates remain depressed. According to Moody’s Investors Service, the U.S. speculative-grade default rate diminished to 1.7% in September, compared to 1.9% in August and 2.8% in September 2013. The default rate is expected to average 2.1% over the fourth quarter and 2.4% over the first half of 2015.
iShares iBoxx $ High Yield Corporate Bond ETF
For more information on the speculative-grade bond market, visit our junk bonds category.
Max Chen contributed to this article.