Assets Swing To And From Junk Bond ETFs

The path of junk bond ETFs has been quite rough for the last couple of months. The space gave a dull show in 2014. The acute plunge in oil prices in the second half of the last year weighed heavily on the space, especially on the energy bonds.

Thanks to the shale-oil boom in the U.S., energy companies spread their presence heavily to the high-yield bond market. Thus, fears of their default amid the oil price rout triggered junk bond sell-offs. The rising rate worries in the U.S. also hurt the space badly.

When oil prices finally saw the face of recovery in early 2015, junk (high yield) bonds seemed to catching investors’ eye. But the return of rising rate concerns again wrecked havoc on the space.

Junk Bonds Space: A Star Earlier

Investors should note that over the last one-month period (as of May 6, 2015), WTI crude recovered over 10% while Brent crude advanced about 13%. Investors heaved a sigh of relief as the oil-induced sell-offs in the junk bond space seemed over (read: 4 ETF Losers of 2014 Hoping for a Rebound in 2015).

The quest for higher yields had been another driver of high-yield bonds’ prosperity till May 6. Per Bloomberg, thanks to almost zero-or-negative-yield scenario in the Euro zone and Japan, investors flocked to the global high-yield space, betting about $9 million in assets in the year-to-date frame.

The Research house went on delivering data like ‘flows into junk-bond ETFs in the first four months of the year exceeded any comparable period since EPFR Global began compiling the data in 2007’. Bloomberg revealed, on May 4, that government bonds worldwide valued at about $2.36 trillion sport negative yields, which left investors with no options other than taking high risks.

After all, countries across the globe, from Europe to Asia-Pacific, jumped on the bandwagon of interest rate cuts with some introducing negative rates and launching QE policy to bolster waning growth and ward off deflationary pressures. Among the major central banks, the ECB rolled out the QE measure this year after months of speculation. Back home the Fed is also pointing to a delayed rate hike citing softness in U.S. economic growth.

Trend Reversal

All rosy things became pale on May 6, when a major sell-off hit the sovereign bond market in both Europe and the U.S. Yields on Germany’s 10-year government debt soared to the highest point in six months. This was in stark contrast to the near-zero yields in the earlier part of the year. In fact, short-term bonds offered negative rates then. As of now, a pickup in the inflationary backdrop and the reemergence of the Greek debt default saga point to this sudden change.

U.S. long-term treasuries also followed suit as the Fed commented that bond yields might witness a steep ascent when the rate-hiking decision is actually taken. The Fed has also expressed concerns pertaining to overvaluation of stocks. As of May 6, 2015, the yield on U.S. 10-Year was 2.25% (the highest this year).

This has adversely impacted income-generating low-rated investment avenues and spurred investors to withdraw $2.75 billion of assets from junk bonds this week. Per the source, the outpouring represents the largest weekly withdrawal since the week ended December 17, when the space saw an outflow of $3.1 billion.

Is the Bet That Dubious?

Though yields are rising right now, things should stabilize soon across the pond. After all a QE measure is underway there. Moreover, the U.S. continued to deliver soft job data in April which shows that the Q1 slowdown has spilled over to the current period as well. This should strengthen the argument of a delayed Fed rate hike.

As of May 6, 2015, the spread between Treasury and high yield bonds stands at 4.50% compared with 5.08% recorded at the start of 2015. This indicates that investors still demand lesser premium than comparable Treasury bonds to make up for the default risks associated with junk bonds (read: 3 Income ETFs for Yield Starved Investors).

Bet of the Hour

In such a backdrop, junk bond ETFs having outsized high-yield may weather the downturn to some extent. Peritus High Yield ETFs (NYSE:HYLD)), Market Vectors Emerging Markets High Yield Bond ETF (NYSE:HYEM)), SPDR Barclays (LONDON:BARC) High Yield Bond ETF (ARCA:JNK)) and Interest Rate Hedged High Yield Bond ETF (HYGH) might be the best bets. These offer 9.53%, 6.75%, 5.78% and 5.53% in annual yields (as of May 6, 2015).

Within the ill-fated last five trading sessions (as of May 6, 2015), HYEM and HYHG even advanced 1.32% and 0.6% respectively though HYLD and JNK shed a little 0.02% and 0.2%, respectively.

Investors should also note that HYGH is an intriguing option to play rising rate concerns as this fund holds iShares iBoxx $ High Yield Corporate Bond ETF (ARCA:HYG)) in its basket, while taking short positions in U.S. Treasury futures to mitigate rising rate concerns (read: 5 Ways to Play Rising Rates with Hedged & Inverse ETFs).

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