One of the primary reasons high-yield corporate bond exchange traded funds struggled in 2015 was the market’s harsh treatment of CCC-rated bonds and lower quality debt in the face of falling oil prices and the specter of rising interest rates.
However, some high-yield bond market observers believe lower quality junk bonds could surprise investors if the Federal Reserves proceeds with multiple interest rate hikes later this year. That could benefit exchange traded funds such as the iShares B – Ca Rated Corporate Bond ETF (BATS: QLTC).
QLTC, which turns four later this month, tracks highly speculative, high-yield or “junk” status bonds, with the majority of holdings in the B+/B1 to B-/B3 range. Over 97% of the ETF’s holdings are rated either B or CCC. The $10.7 million ETF could be worth examining for risk-tolerant fixed income investors, particularly if rates climb later this year.
“Directly contrary to the assumptions of the “obvious” strategy of reducing term risk in advance of a rate rise, the best performance by far was observed in the longest maturities (15+ years). Investors should not conclude, however, that the best place to be in an extended rate rise is invariably at the long end of the curve. The 15+ bucket underperformed the all-maturities return by 70 bps in the earlier rate rise. That disparity between the two episodes is further proof that maturity plays no significant role in differentiating returns among high-yield issues when long-term interest rates rise,” said Marty Fridson of Lehmann Livian Fridson Advisors in an S&P Capital IQ note posted by Amey Stone of Barron’s.
[related_stories]Riskier speculative-grade debt and bond-related exchange traded funds have retreated over the past year and are trading at relatively attractive valuations. However, rising corporate default rates could bar the asset category from a full recovery.
The speculative-grade debt market, though, may have a hard time regaining lost ground ahead as credit risk comes back to the forefront. According to ratings agency Standard & Poor’s, more companies have defaulted globally so far this year than during the start of any year since 2009, reports Josie Cox for the Wall Street Journal.
The S&P’s findings mirror Moody’s expectations that corporate defaults could hit its highest rate since the financial crisis, led by the energy and mining sectors. More than 40 issuers of junk corporate debt have defaulted this year.
“Even more surprisingly, the strategy that worked best in a rising rate environment was to lower credit quality, Fridson found. In fact, return was inversely correlated with quality in both time periods,” reports Barron’s.
iShares B – Ca Rated Corporate Bond ETF
