The Federal Reserve raised interest rates by a quarter of a point earlier this month, and there’s no shortage of speculation that the pace of Fed tightening will quicken as 2022 moves along.
As fixed income investors know, this isn’t good news for most of the bond market. However, some analysts see high-yield bonds holding up well this year, and that could prove beneficial for exchange traded funds such as the WisdomTree U.S. High Yield Corporate Bond Fund (CBOE: WFHY).
“Factors favoring high-yield bonds should be an economy that remains strong even as it cools off from last year’s post-pandemic surge, high yield’s lower sensitivity to rising interest rates, and of course, their yield advantage over higher-quality corporate and government bonds,” says Morningstar analyst Dave Sekera.
WFHY, which follows the WisdomTree U.S. High Yield Corporate Bond Index, is designed to identify junk corporate debt displaying attractive fundamental and income traits. Another reason to consider WFHY could be inklings of value in the high-yield bond arena.
“Looking forward, we continue to think there is value in corporate bonds, especially high yield. The main reason is that our U.S. economics team continues to forecast relatively robust economic growth in the United States over the next three years,” adds Sekera.
WFHY has an effective duration of 4.47 years, putting it in intermediate-term territory. That’s a relevant point because investment-grade corporate debt, while safer from a credit perspective, usually has longer durations than junk bonds. The fund’s quality approach steers investors clear of elevated default risk. That’s worth considering as credit spreads rise.
“The corporate credit spread is the amount of extra yield over equivalent maturity U.S. Treasuries that investors earn to compensate them for the risk of weakening credit strength and defaults. In our investment-grade index, the average credit spread has widened 33 basis points thus far this year,” notes Sekera.
WFHY holds about 440 bonds, over 94% of which are rated BBB, BB, or B. The WisdomTree fund sports a 30-day SEC yield of 5.34%. Bottom line: The fund could prove less vulnerable to rising rates than its investment-grade counterparts.
“The credit spread for investment-grade bonds is less than for high yield, and investment-grade bonds often have longer maturities. As such, investment-grade bonds have longer duration and are more sensitive to underlying interest rates. High-yield bonds generally have shorter duration owing to the combination of their higher yield and shorter maturities. As such, high-yield bonds are less sensitive to interest-rate risk,” concludes Sekera.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.