Tax Reform Could Be Good for Higher Quality Junk Bond ETFs

The Tax Cuts and Jobs Act will affect many aspects of the investment landscape, and a few key elements could help bolster more higher quality speculative-grade debt securities and bond-related ETFs.

The newly implemented tax reforms will lower the U.S. corporate tax rate to 21% from 35%, set the amount of interest expense that companies can deduct to 30% of EBITDA and allow companies to fully write off capital expenditures in the year spent for at least the next five years.

“We view these changes as a net positive for the high yield bond market,” and “the new tax plan could impact BB and B rated issuers differently than more highly levered CCC rated issuers,” Eric Legunn, ETF Strategist for Deutsche Asset Management, said in a research note.

The ETF Strategists found that only about 10% of debt securities held by the Xtrackers USD High Yield Corporate Bond ETF (HYLB) may be negatively affected by the new tax regime due to the drop in headline tax rates to 21% and capped interest rate deductibility of 30% of EBITDA, so the majority of HYLB’s portfolio would experience a net positive.