Junk bonds typically exhibit “equity-like” characteristics, strengthening during periods of higher growth in the U.S. Stronger growth translates to less credit risk, or defaults in these speculative-grade debt securities. Heavily leveraged speculative-grade energy companies also appear stronger along with the rebound in crude oil prices – higher oil prices means less risk of defaults in the U.S. energy sector, which makes up about 15% of the high-yield market.
Moreover, some are looking at high-yield bonds to help cushion against any pullbacks associated with rising rates. For instance, HYG comes with an attractive 5.22% 30-day SEC yield, which may help offset any weakness associated with rising rates.
History has also shown that high-yield bonds have exhibited a positive correlation to rate changes, according to S&P Dow Jones Indices’ data. High-yield bonds typically exhibited positive returns when government bond yields rose. In contrast, investment-grade debt showed a negative correlation to interest rates.
In recent years, some market observers have grown wary of the potential liquidity risks associated with ETFs, especially in the event of a sudden sell off – some are concerned that the ETFs may not be able to be efficiently price in the event or heavy redemptions as the underlying junk bond market is notoriously known for illiquid nature. However, iShares noted that 84% of HYG’s trading is on the stock exchange, without a bond needing to be traded. HYG is becoming the go-to junk bond alternative as large traders increasingly look to the liquid ETF as an alternative to the illiquid underlying market.
“With over $750 billion in trades to date, HYG has become a robust source of liquidity for high-yield investors,” according to iShares. “HYG an provide an alternative venue for liquidity when the bond market is closed or impaired.”
Full disclosure: Tom Lydon’s clients own shares of HYG.