As an asset class, high-yield (or junk) bonds have never been
as liquid as U.S. Treasuries or high-grade corporates. However,
that track record has had little impact on ETFs such as the
iShares iBoxx $ High Yield Corporate Bond Fund (NYSE:
HYG
) and the SPDR Barclays Capital High Yield Bond ETF (NYSE:
JNK
). The two largest junk bond ETFs have seen volumes surge even as
turnover in the funds' holdings slide,
according to a recent Bloomberg piece
.
The uptick in junk bond ETF volume comes amid recent
controversy that includes a $725 million redemption in the SPDR
Barclays Capital High Yield Bond ETF in May,
where the seller allegedly took delivery of the
actual bonds
.
Despite the new found scrutiny and a market environment that
would appear to not favor high-yield bonds, funds such as HYG and
JNK have demonstrated their allure to investors. Some say these
funds are even changing the high-yield game.
"They (HYG and JNK) are changing the nature of high yield -
they are making it easier for people to trade in and out of high
yield as an asset class," said Peter Tchir
founder of TF Market Advisors
in an interview with Benzinga. "Daily volumes in the ETF's are
increasing and detracting from individual bond trading -
something dealers don't like. Many investors had to invest in
mutual funds with higher fees and restrictions before this, so
mutual fund managers don't like it either."
Something else dealers and mutual fund managers may not be
fond of is the respective sizes of HYG and JNK. HYG is home to
$14.2 billion in assets under management while JNK's AUM total is
north of $10.4 billion, according to data on the iShares and
SPDRs Web sites. These statistics underscore the notion that
investors are favoring ETFs over individual high-yield bonds.
"If you can buy or sell $25 million of the ETF with a cost of
10 cents, why would you buy 25 individual bonds, probably paying
at least half a point, if not closer to 1 point," Tchir said.
"Bonds are unique in that the price of $1 million high-yield
bonds is quoted better than the price of $10,000. I can't think
of another asset class that provides tighter bid/offer spreads
for larger size trades. A move to smaller lot size in individual
bonds and electronic trading is a likely outcome in my opinion.
Those who laughed at 100 share trades in ETF's are realizing how
quickly those volumes can grow."
New regulations introduced by Congress and the Basel Committee
on Banking Supervision may also be impacting the high-yield bond
market. Banks are being forced to pare their holdings of
corporate bonds, creating confusion and possibly a trading arena
that more closely resembles stocks.
"U.S. banks will hold very little in inventory," Tchir noted.
"The Fed Stress tests also penalized high-yield bonds. It is
causing some confusion, but in my opinion will lead to some
central limit order system, i.e., an exchange, which will focus
on small but frequent trades, around which things like dark pools
will develop. It will look a lot more like equity trading in the
future."
There are issues that regulators could focus on to the benefit
of investors, in Tchir's opinion.
"I would like to see regulators focus on making sure yield to
call or yield to maturity is done accurately and highlighted,
because investors seem to focus on the dividend yield, but in
reality, expected return should be based on yield to call rather
than dividend yield as the pull to par effect is real for an ETF
holder," he said.
Even amid the increased scrutiny and an unfavorable regulatory
backdrop, junk bond ETFs continue to proliferate in number. At
least
six new funds with junk bond allocations have
debuted this year.
Some funds now offer investors exposure to international
high-yield debt.
The prospect of global and emerging market junk bonds has
proven popular with investors. The iShares Global ex USD High
Yield Corporate Bond Fund (BATS: HYXU), a fund more tilted toward
developed markets, has raked in $23.5 million in AUM in less than
three months of trading. In two months on the market, the Market
Vectors Emerging Markets High Yield Bond ETF (NYSE:
HYEM
) and the iShares Emerging Markets High Yield Bond Fund (BATS:
EMHY) have attracted $9.8 million and $14.9 million in AUM,
respectively.
The growth of international issues, as a percentage of the
global high-yield market, has been impressive. International
issues have surged to 35 percent last year from 10.9 percent in
1997, according Bank of America Merrill Lynch. While the growth
of high-yield global bonds as a percentage of the overall market
cannot be ignored, it is clear that if U.S. junk issues warrant
liquidity concerns, foreign junk issues do as well.
"In all cases, it is key to remember that if bonds trade at 1%
bid/offers, you can have a large move in the ETF whenever market
sentiment changes," Tchir said. "So if the market is 'bid
without' the ETF will trade to the offer side or above (a
premium) to where bonds are quoted. That makes some sense as it
is hard to buy bonds, let alone a diversified portfolio.
"When sentiment changes and the market goes 'offered only'
then bonds will have bids drop, but the ETFs will apparently do
even worse, as they will move from trading at or above offer to
at or below bid. A bond might be 99/100 in a good market,
then bad news hits whole market and it goes to 97.5/98.5."
Investors have also shown a willingness to embrace short-dated
junk bonds, a fact highlighted by the success of the SPDR
Barclays Capital Short Term High Yield Bond ETF (NYSE:
SJNK
). SJNK debuted in March and already has almost $112 million in
assets under management. Even with SJNK's stellar start, this ETF
should be viewed with caution, as it deals with other new
high-yield debt funds.
Calling it the "eat like a parrot, poop like an elephant"
phenomena, Tchir said the rush to short dated funds is
frightening. "The amount to be made from short dated is
relatively small, and if a company deteriorates, the short end is
bidless and will trade far worse than I think many retail
investors understand," he said.
For more on junk bond ETFs, click
here
.
(c) 2012 Benzinga.com. Benzinga does not provide investment
advice. All rights reserved.