While yields on developed market sovereign debt, including U.S. Treasuries, remain low, many fixed income investors are showing they are no longer enamored by high-yield corporate debt and the relevant exchange traded funds.
Flows data suggest investors have been departing bellwether junk bond ETFs, such as 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. Although default rates have recently been low, some market observers believe that metric is destined to tick higher due in part to the flailing retail sector.
“Funds that buy bonds of companies with relatively fragile balance sheets had $600 million in withdrawals in the seven-day period through Nov. 9, according to a Bank of America Merrill Lynch report citing EPFR Global data. The trend is borne out by Lipper U.S. Fund Flows data, which shows investors yanking cash out of the U.S. junk-bond market for two consecutive weeks,” according to Bloomberg.
For the week ended Nov. 9th, investors pulled nearly $900 million on a combined basis from HYG and JNK, putting both ETFs in the top 10 for lost assets over that period.
“The yield on U.S. high yield has slipped as spreads have compressed. At 5%, high yield does not seem to offer particularly generous returns, especially when you consider that the long-term average is closer to 10%. Still, a 5% yield looks enticing given the alternatives in other bonds,” according to BlackRock.
Fueling the increased demand for debt assets, tumbling yields on safer government and corporate debt pushed investors toward riskier and higher yielding debt, like junk bonds. Furthermore, U.S. corporate bonds are enjoying a stronger tailwind in an environment of strong economic growth, healthy earnings and dropping default rates.
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HYG’s underlying index, the Markit iBoxx USD Liquid High Yield Index, also requires holdings to have at least $400 million in par value, and the debt issuer must have at least $1 billion in total debt outstanding. Due to their similar focus on liquidity, the two high-yield bond ETFs have similar portfolios.
“High-yield corporate debt has been one of the biggest beneficiaries of central-bank stimulus, which has squeezed spreads in better-quality bonds, forcing investors to seek returns elsewhere,” reports Bloomberg. “Now the market is losing its biggest buttresses as the Federal Reserve raises interest rates and the European Central Bank gets set to curtail its bond-buying program. Higher-risk assets, such as stocks, are also faltering as much-vaunted U.S. tax cuts face delays.”
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