A prominent theme in the high-yield bond market has recently been the vulnerability of exchange traded funds and the junk market itself to falling oil prices.
The quick explanation of this scenario goes something like this: Eager to tap North American shale plays from the Eagle Ford in South Texas to North Dakota’s Bakken Shale and a host of others, mid-level and smaller exploration and production companies have become some of the most prolific issuers of U.S. junk bonds in recent years.
The problem is many of those companies have not generated enough cash and with oil prices tumbling, fears are rising that the U.S. high-yield bond market could see a spate of energy sector defaults going forward. [Oil Slicks for Junk Bond ETFs]
Some big-name junk bond ETFs feature large energy sector allocations, but investors looking to maintain junk bond exposure via ETFs have options for reducing oil and gas exposure. For example, the Market Vectors Fallen Angel High Yield Bond ETF (NYSEArca: ANGL) allocated just 4.6% of its weight to energy issues at the end of November, according to issuer data. That makes energy ANGL’s eighth-largest sector weight.
Fallen angel bonds, debt that was once rated investment-grade but was later downgraded to junk status have outperformed traditional high-yield bonds this year as measured by the BofA Merrill Lynch US Fallen Angel High Yield Index (H0FA) and BofA Merrill Lynch US High Yield Master II Index (H0A0), respectively.
“As of December 9, 2014, H0FA had returned 7.35%, year to date, more than triple the 2.12% return from the broad high-yield bond H0A0 index. This has been due, in part, to H0FA’s lower exposure to the volatile energy sector, according to Fran Rodilosso, Senior Investment Officer for Market Vectors’ fixed income ETFs. Rodilosso noted that energy has been the largest sector weighting in the broad high-yield bond market for the past decade, growing progressively from approximately 8% to 18% year to date in 2014. The energy sector has been the largest contributor to new high-yield bond issuances since 2009.”