After the recent pullback in the junk bond market, high-yield exchange traded funds look more attractively priced, providing investors with a cheaper entry point.
“The category’s sell-off over the past year has made the asset class more attractive based on valuations; the high-yield market might be presenting an opportunity for contrarian investors,” according to Sumit Desai, a senior fixed-income analyst for Morningstar. “To offset the risks inherent in the asset class, we think it’s important for investors to treat high yield as a long-term strategic investment within portfolios rather than a vehicle for market-timing and trading.”
Over the past three months, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) dipped 4.2%, SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) fell 5.2%, PowerShares Fundamental High Yield Corporate Bond ETF (NYSEArca: PHB) dropped 1.4% and AdvisorShares Peritus High Yield ETF (NYSEArca: HYLD) decreased 3.0%. [Why High Yield Still Has a Role to Play]
Desai pointed out that after driving much of the speculative-grade bond market returns for much of 2014, the energy sector is dragging on returns in 2015 after the plunge in oil prices raised default risks among energy producers. Many high-yield managers believe the energy sector can survive with oil prices north of $75 but there may be increased defaults if oil remains below $60 per barrel – West Texas Intermediate crude oil futures are now hovering around $40 per barrel.
Energy sector makes up about 13% of the Bank of America Merrill Lynch High Yield Master II Index. The junk bond ETFs also include significant exposure to the energy sector – for example, HYG has a 12.7% weight toward energy sector debt.
After the poor performance of junk bonds this year, investors may see that high-yield debt valuations look much better, with yields near multi-year highs. HYG has a 6.63% 30-day SEC yield, JNK shows a 6.62% 30-day SEC yield, PHB has a 4.75% 30-day SEC yield and HYLD has a 10.53% 30-day SEC yield.
“One positive from this poor performance is that valuations for high-yield bonds now appear much more reasonable, creating a potentially attractive entry point for investors,” Desai added.
Nevertheless, there are still some risks. For instance, Desai argues that high-yield bonds could see a sell-off during a rising rate environment after years of low interest rates pushed more investors into speculative-grade debt in search of yield. [3 Reasons to Consider Short Duration High Yield]
For more information on the speculative-grade debt market, visit our junk bonds category.
Max Chen contributed to this article.