Avoid Defaults With a Quality Approach to Junk Bonds | ETF Trends

Data indicate high-yield bond defaults are on the rise, but investors looking to remain engaged with the asset class while avoiding defaults can consider the FlexShares High Yield Value-Scored Bond Index Fund (NYSEArca: HYGV).

HYGV focuses on value by pursuing the higher risk/return potential found by concentrating on a targeted credit beta; utilizes Northern Trust Credit Scoring methodology to eliminate bottom 10% of issuers; performs liquidity assessment based on issuer’s debt outstanding, age and remaining time to maturity with the purpose of eliminating the bottom 5% illiquid securities; and intends to match the duration of a market cap-weighted index (ICE BofAML US High Yield Index), while maintaining sector neutrality.

The strategy is noteworthy as more issuers default on obligations in the wake of the coronavirus pandemic.

“The U.S. high yield trailing 12-month default rate will approach 5.5 percent by the end of July, the highest level since May 2010,” said Fitch Ratings in a recent note.

What’s Next

HYGV seeks investment results that correspond generally to the price and yield performance of the Northern Trust High Yield Value-Scored US Corporate Bond Index (the underlying index). The fund generally will invest at least 80% of its total assets (exclusive of collateral held from securities lending) in the securities of its underlying index. The underlying index reflects the performance of a broad universe of U.S.-dollar denominated high yield corporate bonds that seek a higher yield than the overall high yield corporate bond market, as represented by the Northern Trust High Yield US Corporate Bond Index.

“Default volume tallied $41.1 billion during the second quarter, exceeding the previous record of $39.5 billion set back in 2009. Frontier Communications and Chesapeake Energy made up nearly half that total. Overall, telecommunications and energy accounted for 70% of the total volume,” said Eric Rosenthal, Fitch Senior Director of Leveraged Finance.

The majority of the defaults were in the energy sector as companies like Chesapeake Energy and California Resources are facing bankruptcy with bond interest payments forthcoming. According to the report, the energy trailing 12-month default rate is at 11.1% but could reach 14% by the end of June and 17% by the end of the year.

“The recent default wave resulted in Fitch’s Top Bonds of Concern list total falling to $30.2 billion — the lowest amount in a year — from the May peak of $52.4 billion. The combined Top Bonds and Tier 2 list total is $215.1 billion, which has more than doubled since the pandemic began, to comprise 16 percent of the index,” according to Fitch.

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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.