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, and other high-yield corporate bond ETFs are often thought of as among the more vulnerable asset classes to rising interest rates.
Historical data paints a different picture. 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.
“Duration measures bonds’ direct exposure to interest rates. For spread products such as corporate bonds, their total return is also sensitive to changes in credit spread. Empirically, corporate bonds’ total returns tend to be less sensitive to interest rates compared with what is indicated by their duration measure, due to the negative correlation between interest rate and credit spread changes,” according to S&P Dow Jones Indices.
Interestingly, junk bonds often display positive correlations to changes in interest rates.
“Both high yield indices demonstrated a positive correlation with rate changes, meaning that high yield bonds had positive returns when government bond yields rose. In contrast, investment-grade corporate bonds showed a negative correlation with interest rates. The positive correlation of high yield bonds was further corroborated by the negative correlation of credit spreads and interest rate changes, indicating that when government bond yields moved higher, credit spreads tightened,” notes S&P Dow Jones Indices.
Alternatively, investors may also consider inverse or short junk bond ETFs to hedge a dip in speculative-grade debt markets. The recently launched Direxion Daily High Yield Bear 2X Shares (NYSEArca: HYDD) tries to reflect the daily performance of -2x or -200% performance of the Barclays U.S. High Yield Very Liquid Index. Additionally, the ProShares Short High Yield ETF (NYSEArca: SJB) takes the inverse -1x or -100% daily performance of the Markit iBoxx $ Liquid High Yield Index.
For more information on the fixed-income market, visit our bond ETFs category.