The high-yield bond market is encountering significant duress this year due to weakness in the oil patch and concerns about rising default rates, among other factors, but investors can avoid some of the pitfalls of this asset class by focusing on fundamentals with the WisdomTree U.S. High Yield Corporate Bond Fund (CBOE: WFHY).

WFHY’s fundamentally-weighted methodology could serve income investors well if defaults increase. The fund tracks the WisdomTree U.S. High Yield Corporate Bond Index, which uses a multi-step fundamental screen to steer investors away from the junkiest of the junk bonds. That’s important at a time when many high-yield issuers are under scrutiny due to financing needs.

“As the economic effects of ‘stay at home/social distancing’ policies continue, corporations have been faced with challenging decisions regarding liquidity and financial solvency,” said WisdomTree in a recent note. “Some corporations are in dire need of cash. As their revenues shrink to unfathomable lows, companies must continue to make interest payments to lenders and cover their capital expenditures, which can only be reduced by so much.”

WFHY Struts Its Stuff

Importantly, WFHY’s index methodology has helped that benchmark avoid half the corporate defaults seen in the U.S. this year.

“The WisdomTree Index uses a combination of factors to identify bonds with favorable risk/reward in high yield. Step one of the process is to exclude issuers that do not have publicly traded equities and thus may not report public financials. In our view, these companies are under less scrutiny to manage a healthy balance sheet. This approach has helped our Index avoid nine defaults so far this year,” according to WisdomTree.

Data confirm that the average WFHY issuer generates more cash flow than the average member of a standard high-yield bond benchmark.

“Over the past 12 months, the median issuer in the WisdomTree U.S. High Yield Corporate Bond Index generated $423 million of free cash flow, compared to only $240 million for the median public issuer in the broad U.S. high-yield debt arena,” according to WisdomTree.

Relevant to today’s cash-centric environment is the fact that WFHY components have more cash on hand and superior access to capital relative to traditional junk bonds.

“The median issuer for WisdomTree’s underlying strategy has $598 million of cash, compared to $360 million cash in the broad U.S. high-yield bond market. Lastly, let us consider access to cash through credit facilities. The median issuer in the WisdomTree U.S. High Yield Corporate Bond Index has access to nearly $1.1 billion, compared to $850 million for the median public issuer in the ICE BAML U.S. High Yield Bond Index,” according to WisdomTree.

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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.