The Rising Debt Distress of Junk Bond ETFs | ETF Trends

Junk bond-related exchange traded funds that that cover some of lowest-rated companies may be in for more pain ahead as distressed debt levels in the U.S. rise.

According to ratings agency Standard & Poor’s, the number of companies with the lowest credit ratings and negative outlooks increased to 195 in December, the highest level since March 2010, reports Matt Krantz for USA Today.

The debt markets are beginning to weigh in on the double whammy from rising interest rates and weakening profits in several sectors, notably commodities-related producers.

For instance, among the weakest areas in the debt market, oil and gas sector makes up 34 of the lowest-rated credit issuers with negative outlooks in December. Additionally, financial companies were a close second, with 33 of the weakest links, according to the S&P. [Rising Default Risks in Junk Bond ETFs]

Oil and gas sector makes up the largest percentage of distressed debt at 37% after the plunge in crude oil prices weighed on profits and added to uncertainty for the sector ahead. Meanwhile, metals, mining and steel are also under pressure, with a 72% distress ratio, due to falling demand for industrial metals, notably from China and a weakening global economy.

Consequently, the more pessimistic outlook has dragged on the high-yield bond market. For instance, the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) fell 6.9% and iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) dropped 5.1% year-to-date.

The two junk bond ETFs include some lower quality speculative-grade debt that are more at risk of defaults. JNK’s portfolio includes 15.6% CCC or lower-rated bonds, 41.1% B and 40.7% BB. HYG includes CCC 9.4%, 38.4% B and 49.8% BB.