The United States Oil Fund (NYSEArca: USO) is off 6.4% in the past month as West Texas Intermediate, the U.S. benchmark oil contract, ominously descents to $80 per barrel.
Oil’s slide has wrought havoc for futures-based ETFs, such as USO, as well as scores of equity-bae funds with energy sector exposure. After a 9.5% third-quarter loss, was once the top-performing sector in the S&P 500 earlier this year has now turned into one of the worst groups. [Dour View on Energy ETFs]
Of the 25 worst-performing exchange traded funds over the past month, 12 are equity-based energy funds. However, weakness in the energy sector could be problematic for some an asset class some investors may not be overlooking as a victim of energy’s slide: High-yield bonds and the corresponing ETFs.
Booming production at the Eagle Ford Shale and other shale formations has helped make Texas the envy of large state economies. That same theme has also been viewed as one of the more favorable long-term catalysts for ETFs ranging from the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEArca: XOP) to the Market Vectors Unconventional Oil & Gas ETF (NYSEArca: FRAK), but oil’s decline is threatening producers ability to profitably tap North American shale plays. [Fracking ETFs Foiled by Slumping Oil Prices]
“Texas is the anchor to shale production, employment growth, positive real estate trends, and overall positive moral. With Crude Oil at or below the cost of production for many project, the State with the highest economic multiple needs to contract,” said Rareview Macro founder Neil Azous in a research note.
But there’s more, including the threat falling oil prices pose to the high-yield bond market.
“The consequences of that are still unknown in many respects, including the financing impact on High Yield credit, Master Limited Partnerships (MLP) and the like. Of note is that investors up until now had not factored a lower crude price into spaces that have low liquidity like junk bonds and MLPs. This is a canary in the coal mine for High Yield,” notes Azous.
His assessment warrants attention as the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG), the largest junk bond ETF, allocates 14.7% of its weight to oil and gas issuers, making that the ETF’s largest sector weight. Approximately 120 of the high-yield bonds held by the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the second-largest junk bond ETF, are issued by companies engaged in the exploration, production or transportation of coal, natural gas or oil.