After fixed-income assets dipped in response to the recent rise in rates, high-yield speculative-grade debt and related exchange traded funds could outperform ahead.
“We continue to expect that high-yield bonds will provide better returns than investment-grade as underlying rates tick up and moderate economic growth holds down defaults,” according to Morningstar Corporate bond strategist, David Sekera.
While the fixed-income universe retreated over last month, high-yield bonds continued to shine. The BofA Merrill Lynch US High Yield Index rose 1.2% in April and has gained 3.8% year-to-date.
Looking at ETF options, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) only added 0.2% so far this year, whereas the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) rose 2.6% and iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) gained 3.5%. [Investors Returning to Corporate High-Yield Bond ETFs]
Sekera argued that the gains in the high-yield segment were attributed to the tightening credit spreads as the average credit spread of junk bonds tightened over Treasuries, with a major portion of the tightening coming out of the energy sector as oil prices rebounded this year.
Junk bond ETFs, which hold about 10% to 15% in energy-related debt, pulled back late last year after the plunge in oil prices raised credit concerns on some of the riskier loans from the nascent U.S. shale oil industry. [Energy Rebound Lifts Junk Bond ETFs]
Over the near-term, Morningstar also anticipates corporate bonds to outperform Treasuries, arguing that as the European Central Bank undergoes its quantitative easing program, the proceeds will likely be reinvested in the corporate debt markets. Consequently, the demand should help keep credit spreads from widening and could cause credit spreads to tighten even more against Treasuries, Sekera added.
The iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) has declined 2.0% over the past month after yields on 10-year Treasuries rose about 30 basis points from its mid-April low. IEF gained 0.9% year-to-date.
For more information on the speculative-grade debt market, visit our junk bonds category.
Max Chen contributed to this article.