It’s a new year and perhaps that will mean better things for bonds and bond ETFs, including high-yield corporate fare. As things stood on Thursday, January 26, the widely followed Markit iBoxx USD Liquid High Yield Index is higher by nearly 4% year-to-date.
That could be a sign that bond market participants are pricing the Federal Reserve halting its rate-hiking campaign after the first quarter. Should that prove accurate, it could fuel a fixed income rebound, potentially benefiting exchange traded funds such as the IQ MacKay ESG High Income ETF (NYSE Arca: IQHI) in the process.
The actively managed IQHI attempts to beat the Bloomberg Very Liquid High Yield Index and could be a compelling idea in 2023 for investors positioning for a junk bond resurgence and those seeking the combination of environmental, social, and governance (ESG) virtue with high-yield corporate debt.
“There’s just no escaping the bond math. For every 1% increase or decrease in interest rates, a bond’s price will change by approximately 1% in the opposite direction for every year of its duration. Therefore, bonds with lower duration have lower sensitivity to interest rate changes, while higher-duration bonds have higher rate risk,” according to BlackRock research.
Obviously, credit risk is a primary concern in any environment when it comes to junk bonds and bond ETFs such as IQHI, but interest rate risk is clearly an important consideration today. As of the end of last year, IQHI’s effective duration – a measure of the fund’s sensitivity to change in interest rates – was 4.14 years. That’s intermediate-term territory and while that’s not short or ultra-short duration, it is a sign that IQHI could benefit from declining Treasury yields.
“We think the Fed is nearing the end of its rate hiking cycle, so the coming year is likely to be kinder for bonds. Even if we were to see additional rate movement, though, the higher level of coupon income today would likely offset negative price action materially in long-duration bonds and entirely in short-duration bonds,” added BlackRock.
Even with that benefit, IQHI offers investors substantial income potential as highlighted by a 30-day SEC yield of 7.27% at the end of last year. Additionally, while default rates are expected to remain tolerable this year, IQHI exercises some caution on the credit front as it allocates just 7.48% of its roster to the bonds with highly speculative grades of “CCC” or worse.
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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.