High-Yield Bond ETFs The Good, The Bad

High-yield bond exchange traded funds have been among the better performing fixed-income investments in recent weeks as the asset category steadily strengthened while Treasuries sold off, but junk bonds are not without their risks ahead.

“We can’t help but feel that 2017 is likely to be a finely balanced year, with as many reasons to be optimistic as cautious,” Rob Bush, ETF Strategist for Deutsche Asset Management, said in a note.

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. rose 1.9% and 2.3% over the past month, respectively. The recently launched Deutsche X-trackers USD High Yield Corporate Bond ETF (NYSEArca: HYLB) has also quickly attracted investors’ attention, accumulating $136.2 million in assets under management since its December 7 launch.

On the positive side, a strengthening economy will help diminish credit risk. Deutsche’s CIO team is forecasting U.S. growth of 2.2% next year, or a little more than the 2.1% five-year average. Due to junk bond’s more “equity-like” nature compared to Treasuries or investment-grade debt, high-yield bonds could strengthen on the higher growth environment in the U.S., especially with rebounding oil prices that would further diminish credit risk for energy-related speculative-grade debt, the largest sector that makes up about 15% of high-yield market.

While interest rates are rising, rates are still hovering near historical lows, which will help make it easier for companies to repay debt or reduce default risks. More quick-witted corporate treasurers have already locked into low, long-term loans, further mitigating default risks.

Moreover, President-elect Donald Trump may enact looser regulatory restrictions and corporate tax cuts that could allow many companies to repatriate cash and enhance corporate earnings. Bush argued this would mean more cash on balance sheets and less concern over meeting interest payments.