The capital markets are hanging on to any sliver of positive news whether it’s progress regarding a U.S.-China trade deal or more dovishness from the Federal Reserve next week, which could trigger a shift back to risk-on where high-yield fixed income can be a more attractive option than leveraged loan options that feature a floating rate component.
The latter has been seen as the go-to default play for rising rates as short-term rate adjustments would be accounted for in debt issues that eponymously float with any central bank rate hikes. However, some analysts are actually pointing to high yield debt as the better option versus leveraged loans, which are extended to companies that already carry a significant debt load.
“So leveraged loans are performing worse than high yield,” said Peter Tchir, a contributor at Forbes. “Some of this recent under-performance can be blamed on interest rates as high yield benefits from the recent drop in treasury yields and leveraged loans, which are floating rate, are less attractive now that more market participants believe the Fed will have to hike less often than they wanted to.”
As Tchir notes, the Federal Reserve has been increasing its dovish tones as of late even if the general consensus is that a rate hike in December will most certainly occur as the CME Group’s FedWatch Tool, an algorithm that calculates the probability of a rate hike in a given month, is now showing an 80.1% chance the Fed will institute a fourth rate hike to end 2018.
That need for high-yielding assets could be spurred on even more should a year-end rally occur in U.S. equities. Even though both the stock and bond markets march to the beat of their down drum, a risk-on sentiment could fuel either asset class.
High-Yield ETF Options
To satiate an appetite for high yield, investors can look to fixed-income exchange-traded funds (ETFs) like the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG), ProShares High Yield—Interest Rate Hedged (BATS: HYHG) and WisdomTree Interest Rate Hedged High Yield Bond ETF (NasdaqGM: HYZD).
HYG tracks the investment results of the Markit iBoxx® USD Liquid High Yield Index, which is comprised of high yield U.S. corporate bonds that have less than investment-grade quality. HYHG tracks the performance of the Citi High Yield Index and allocates 80% of its total assets in high-yield bonds and short positions in Treasury Securities in order hedge against rising rates HYZD seeks to track the price and yield performance of the BofA Merrill Lynch 0-5 Year U.S. High Yield Constrained, Zero Duration Index, which provides long exposure to the BofA Merrill Lynch 0-5 Year U.S. High Yield Constrained Index while seeking to manage interest rate risk through the use of short positions in U.S. Treasury securities.
For more trends in fixed income, visit the Fixed Income Channel.