A Good Time to Revisit Junk ETFs

The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the two largest high-yield corporate bond exchange traded funds by assets, have been pressured over the past year amid interest rate speculation and slumping oil prices.

But with plenty of bad news baked into these and other junk bond ETFs, it could be time to revisit the asset class, particularly with oil prices rebounding.

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.

“And defaults almost never run at the long-term 4.6% average. Instead, they often run below 3% for long stretches of time, when the market is calm, and then spike in the 10%-15% range,” reports MarketWatch. “A difficulty in estimating defaults is that they aren’t correlated to the severity of recessions. The 2008-2009 period was the ‘least bad’ default cycle, according to Inker. The 2000-2003 cycle, by contrast, featured the worst defaults despite containing the mildest recession in U.S. history.”

HYG and JNK feature exposure to energy debt, but there are alternatives for investors looking for junk bond ETFs with higher credit quality.