Will There Be an Oversupply of High Yield in the Bond Market?

With interest rates at historic lows, companies are taking advantage of the opportunity to refinance current debt for lower rates via bond offerings, especially those that are cash-strapped during the COVID-19 crisis. However, this could spur a glut in high yield debt issues that could flood the bond markets, which isn’t helped by an increasing number of downgrades.

“So far this year, U.S. credit-ratings firms have downgraded $144 billion of bonds from investment grade to junk, according to Citigroup. Many of those bonds, called ‘fallen angels,’ were added to the ICE BofA High Yield Index at the start of this month,” a Bloomberg report noted. “Those downgrades have already changed the composition of the market in notable ways. First, they have increased the duration, or interest-rate sensitivity, of the index. Second, they have increased the relative size of bonds rated BB+, BB, and BB-, the top three rating tiers of the junk-bond market.”

“The so-called BBs are now a larger share of the high-yield market’s value than any time on record, Citigroup wrote in a May 8 note. In other words, the fallen angels may have actually increased the quality of the high-yield bond market,” the report added further.

However, this was mostly due to a re-shifting of debt quality ratings and the issuance of more bonds.

“Technically the quality of the [high yield]market has improved through the cycle but that happened primarily due to defaulted names dropping out and higher quality survivors issuing new bonds,” Bank of America strategists noted. “Fallen angels on their own are an insufficient factor to offset the impact of negative rating actions within [high yield].”

Bond Options for ETF Investors

As the drama in the bond markets continues to play out, low rates have high yield bond seekers looking for ways to earn a higher-than-average return on debt, which they may find in the VanEck Vectors Fallen Angel High Yield Bond ETF (BATS: ANGL). ANGL seeks to replicate as closely as possible the price and yield performance of the ICE BofAML US Fallen Angel High Yield Index.

The index is comprised of below investment grade corporate bonds denominated in U.S. dollars that were rated investment grade at the time of issuance. ANGL essentially focuses on debt that has fallen out of investment-grade favor and is now repurposed for high yield returns with the downgraded-to-junk status.

If investors aren’t willing to assume the risk of high yield debt issues, there are also investment grade options to consider. ETFs in this category include the iShares Intermediate Credit Bond ETF (NASDAQ: CIU), iShares iBoxx $ Investment Grade Corp Bd ETF (NYSEArca: LQD) and Vanguard Interm-Term Corp Bd ETF (NASDAQ: VCIT).

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