Will Zombie Companies Result from Fed’s High Yield Backing?

The Federal Reserve made a bold move to backstop high yield debt amid the coronavirus pandemic, but one byproduct that could emerge is the increasing number of zombie companies.

Interest rates have been low relatively low since the 80s, spawning a rise in these zombie firms characterized by their lack of experience in the industry in addition to their low profitability. This rise in zombie firms tends to crowd out investment as well as employment in more productive firms.

A low-interest rate environment like now reduces the pressure on these firms to generate a profit and the propensity for banks to keep lending them money means the availability of a capital infusion via more credit is easier to access. Furthermore, the effect of this growing number of zombie firms means that economic productivity is lower in the aggregate as these firms are typically marked by low labor productivity and total factor productivity with respect to their more productive peers.

“The Fed opened up the high-yield market for almost everybody and that raises the specter of zombie companies,” said Allianz chief economic advisor Mohamed El-Erian on “Squawk Box.” “We’ve got to be careful about this because that eats away at what makes America special. That’s the reason why we don’t ever bet against America, because of its dynamism.”

“My own sense is the Fed went too far in going into the high-yield market, but I understand why they did it,” El-Erian added. “But on the other hand, you get people who shouldn’t be borrowing raising money.”

High Yield Bond ETF Options

Investors looking to add high yield bond exposure to their ETF portfolios can look at the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Bloomberg Barclays High Yield Bond ETF (JNK). Some market experts question whether this move is nothing more than a small bandage on a gunshot wound.

Investors contemplating a high yield option can take a look at the Goldman Sachs Access High Yield Corporate Bond ETF (GHYB). GHYB seeks to provide investment results that closely correspond, before fees and expenses, to the performance of the FTSE Goldman Sachs High Yield Corporate Bond Index.

The fund seeks to achieve its investment objective by investing at least 80% of its assets (exclusive of collateral held from securities lending) in securities included in its underlying index. The index is a rules-based index that is designed to measure the performance of high yield corporate bonds denominated in U.S. dollars that meet certain liquidity and fundamental screening criteria.

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