The high-yield bond market was active though not necessarily bad in August, but all that activity can serve to highlight the quality benefits that come along with the FlexShares High Yield Value-Scored Bond Index Fund (NYSEArca: HYGV).
HYGV focuses on value by pursuing the higher risk/return potential found by concentrating on a targeted credit beta; utilizes Northern Trust Credit Scoring methodology to eliminate bottom 10% of issuers; performs liquidity assessment based on issuer’s debt outstanding, age, and remaining time to maturity with the purpose of eliminating the bottom 5% illiquid securities; and intends to match the duration of a market cap-weighted index (ICE BofAML US High Yield Index), while maintaining sector neutrality.
“Here is a striking fact about the high-yield market’s rebounds to these symbolically important levels: They occurred in the context of extremely tight credit conditions, which normally clobber speculative-grade bond prices,” writes Martin Frisdon, Chief Investment Officer of Lehmann Livian Fridson Advisors in a post for S&P Global Market Intelligence. “The Federal Reserve’s latest quarterly survey of senior loan officers found that 71.3% of banks are tightening credit standards for large- and medium-sized companies. Zero percent are easing standards, for a difference of 71.3 percentage points.”
HYGV is significant at a time when many high-yield investors are still chastened by rampant credit downgrades. The weakness comes right after a record borrowing binge in recent years as many companies looked at the relatively low-rate environment as a cheap opportunity to borrow, with more investors willing to chase after speculative-grade debt for their more attractive yields.
HYGV also matters owing to the aforementioned spread in tightening standards.
“Over the past quarter-century there have been only six other months in which that differential has exceeded 60 percentage points,” writes Fridson. “In none of those months did the ICE BofA US High Yield Index’s price exceeds 63.95. The low was 56.58 in November 2008, during the Great Recession. In those same six months, the high-yield spread ranged from +1,617 to +1,988 bps.”
HYGV’s index reflects the performance of a broad universe of U.S.-dollar denominated high yield corporate bonds that seeks a higher total return than the overall high yield corporate bond market, as represented by the Northern Trust High Yield US Corporate Bond IndexSM. The fund generally will invest under normal circumstances at least 80% of its total assets (exclusive of collateral held from securities lending) in the securities of its index.
“As a final observation about valuations, we note that on Aug. 31 the distress ratio (percentage of issues in the ICE BofA US High Yield Index with option-adjusted spreads of +1,000 bps or more) hit an all-time low for a recessionary month, at 11.58%,” writes Fridson. “The previous low was 15.74% in May 2008, while the record high for the series was set in November 2008 at 84.00%.”
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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.