Broadly speaking, junk bonds reclaimed the bulk of losses incurred during the March sell-off, but investors mulling the asset class should still evaluate fundamentals, a task made easier with the WisdomTree Fundamental U.S. High Yield Corporate Bond Fund (CBOE: WFHY).
WFHY’s underlying benchmark “uses a combination of factors to identify bonds with favorable risk/reward in high yield. Step one of the process is to exclude issuers that do not have publicly traded equities and thus may not report public financials. In our view, these companies are under less scrutiny to manage a healthy balance sheet. This approach has helped our Index avoid nine defaults so far this year,” according to WisdomTree.
Although the Federal Reserve is providing support for the high-yield market, which was needed following the March blowout, market observers are still concerned about weakening credit quality.
Weighing in on WFHY
“In fact, HY experienced its worst two-week period during the mid to latter portion of that month,” notes WisdomTree. “As a result, HY spreads rose 750 basis points (bps) to +1,100 bps, the second-highest level on record. This widening was only eclipsed by the global financial crisis, and as you can clearly see, this year’s widening was far greater than the early 2016 and late-2018/early-2019 episodes.”
WFHY’s fundamentally-weighted methodology could serve income investors well if defaults increase. The fund tracks the WisdomTree U.S. High Yield Corporate Bond Index, which uses a multi-step fundamental screen to steer investors away from the junkiest of the junk bonds. That’s important at a time when many high-yield issuers are under scrutiny due to financing needs.
Said another way, investors concerned about rising default rates among junk issuers may want to consider WFHY because its methodology can mitigate default risk.
“Since the tumultuous selling in March, the U.S. HY sector has reversed course with spreads narrowing by roughly 500 bps as of this writing,” writes WisdomTree’s Kevin Flanagan. “In other words, spreads have retraced 65% of their widening from the peak that was registered on March 23. While this is certainly good news, I feel U.S. HY corporates still have room for further improvement.”
Relevant to today’s cash-centric environment is the fact that WFHY components have more cash on hand and superior access to capital relative to traditional junk bonds. WFHY is up 16.47% in the second quarter.
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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.