Investors Have Grown More Comfortable with Junk Bonds

As default rates among low-rated U.S. companies dropped to their lowest level in months, fixed income investors have grown more “risk-on.”

The iShares iBoxx $ High Yield Corp Bond ETF (NYSEArca: HYG) increased 0.9% year-to-date while the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) fell 4.8%.

Additionally, ETF investors have exhibited a higher preference for riskier assets. Over the past week alone, the iShares iBoxx $ High Yield Corp Bond ETF attracted $1.7 billion in net inflows whereas the iShares iBoxx $ Investment Grade Corporate Bond ETF experienced $2.2 billion in net outflows, according to ETFdb data.

Bolstering the risk-on bets, default rates on low-rated U.S. companies declined to 3.15% as of March, their lowest level in 10 months, the Wall Street Journal reports.

The low defaults rates have helped support a strong rebound in the prices of credit markets that were initially pummeled by the Covid-19 pandemic, which triggered a flight from risk.

With the increased risk-on attitude, the average yield on a Bloomberg Barclays index of junk bonds as of Thursday was 3.9%, or 0.1 percentage point above the record low of February. Yields and bond prices exhibit an inverse relationship.

Steven Oh, head of global credit at PineBridge Investments, argued that the lower interest rate environment and demand for more attractive yielding assets have helped companies improve operations.

“Access to liquidity has been the most crucial piece of the puzzle,” Oh told the WSJ. “Markets have more than sufficient liquidity to stave off defaults.”

Looking ahead, analysts project default rates on junk bonds and leveraged loans could fall back to pre-pandemic levels over the next year.

“You’re going to see more money come into loans and junk bonds because where else are investors going to get yield,” John McClain, portfolio manager at Diamond Hill Capital Management, told the WSJ.

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