The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) have already been identified as vulnerable to declining oil prices as 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.
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.
The Royal Bank of Scotland projects that U.S. default rates could double from about 2% to 4% by the end of the year. UBS has warned that distress in energy bonds can spread to other areas of the high-yield market as soem companies are exposed to the resulting investment decline and job losses.
While some market observers see value in high-yield bond ETFs, risks remain as junk 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]
“Moody’s Liquidity Stress Index rose to 5.1% in August from 4.3% in July, placing it at its highest level since December 2010, the rating agency said in a statement. The index measures the number of companies that carry Moody’s lowest liquidity rating of SGL-4. The index rises when more issuers are placed in that category, and it falls when liquidity improves,” reports Ciara Linnane for MarketWatch.
On the upside, market participants might be overstating rate risk as it pertains to high-yield bonds and ETFs like HYG and JNK. In fact, junk bonds can actually prove durable when rates rise.
“It’s also important to remember that high yield has actually performed quite well in rising rate periods, as the chart below shows. It also tends to perform well in a positive growth environment, holding a 0.76 correlation with U.S. PMI, according to our analysis using data from Bloomberg,” said BlackRock Global Chief Investment Strategist Russ Koesterich in a note out last month.
iShares iBoxx $ High Yield Corporate Bond ETF
Tom Lydon’s clients own shares of HYG and JNK.