Credit spreads on speculative-grade junk bonds have rallied back to levels last seen before the sell-off in 2015.
Huge oscillations in oil prices have caused spreads to widen in recent weeks, but junk bond investors who are wary of credit risk among the more leveraged oil producers can turn to a relatively new high-yield, ex-energy exchange traded fund.
The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) gained 10.9% and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) rose 11.6% year-to-date, rallying above their 2015 highs and regaining most of the lost ground earlier this year as diminishing volatility and an extended low-rate environment fueled a more risk-on attitude among fixed-income investors.
However, speculative-grade debt slipped toward the end of July on renewed risk aversion associated with plunging crude oil prices, with the West Texas Intermediate oil market falling back into a bear market. Junk bonds have exhibited some very high correlation to crude oil prices as observers fear that lower oil prices would make it harder for highly leveraged oil producers, namely the upstart shale oil industry, to service the debt and potentially cause a wave of defaults.
Energy company debt defaults have driven S&P’s trailing US junk bond default rate to a six-year high of 4.5% in July. Standard & Poor’s rating agency also projects the rate will rise to 5.3% by March 2017. Energy and natural resource companies made up over half of the 105 companies that defaulted globally this year.
While the junk bond ETFs pushed higher over the past two weeks, it is clear that fixed-income investors were loath to shake off the connection between high-yield debt and crude oil, pressuring junk bond ETFs as oil prices plunged into a new bear. The junk bond ETFs include some significant exposure to the energy sector. For instance, HYG has a 13.0% tilt toward energy producers.[related_stories]
However, yield-starved investors who are interested in the junk bond space but are wary of further credit risks among energy producers may consider a recently launched high-yield, ex-energy bond ETF, the iShares iBoxx $ High Yield ex Oil & Gas Corporate Bond ETF (NasdaqGM: HYXE). HYXE basically tracks the same group of debt securities as HYG except it does not hold exposure to energy companies.
Specifically, HYXE includes a 28.3% positions toward the communications sector, 14.7% consumer non-cyclical, 14.6 consumer cyclical, 9.5% capital goods, 8.7% tech, 7.0% basic industry, 5.3% finance, 3.4% electric, 3.4% banking, 1.3% transportation and 1.2% to other industrials.
HYXE shows a 3.97 year effective duration, or sensitivity to changes in interest rates, while HYG has a 3.82 year duration.
However, since it excludes the higher yielding energy sector, HYXE comes with a slightly lower 4.94% 30-day SEC yield, compared to HYG’s 5.55% 30-day SEC yield. The lower yield, though, comes with peace of mind in knowing that one is not exposed to a riskier segment of the speculative-grade debt market.
For more information on the speculative-grade debt market, visit our junk bonds category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.