High Yield ETFs Demonstrate Formidable Strength

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There is a saying on Wall Street that “credit leads.” The meaning of this adage is that high yield investments are often the first to falter during a significant downturn.  Junk bonds, bank loans, and other riskier types of debt have often been analogized to the canary in the coal mine when gauging the health of global markets.  Perhaps it is because these investments have historically been quite sensitive to liquidity and risk appetites as investors shift their capital accordingly. 

If this maxim is indeed true, the relative strength of credit-sensitive investments during the February stock market correction is a positive sign. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) fell just 3% from high to low as the SPDR S&P 500 ETF (SPY) nosedived more than 10%. HYG has since recovered the majority of those losses and is within 1% of its previous high.

This exchange-traded fund is one of the most heavily-traded in the high yield world and beloved by income enthusiasts for its above-average dividends.  HYG owns a basket of over 1,000 fixed-income securities issued by corporations with below investment grade credit ratings.  It sports a 30-day SEC yield of 5.52%, an expense ratio of 0.49%, and an effective duration of 3.85 years. 

As a percentage of total market value, 48% of the underlying holdings in HYG are clustered around the BB rating category, according to S&P data.  That is followed by 38% in the B category and nearly 11% rated CCC. 

Those who may opt for a slightly riskier portfolio may be interested in the SPDR Bloomberg Barclays High Yield Bond ETF (JNK).  It shifts approximately 4-5% of its portfolio down the credit ladder, which also boosts the current 30-day SEC yield to 5.69%. 

It’s interesting to note that HYG and JNK have experienced less overall influence by the recent move higher in interest rates as well.  This risk factor is traditionally more prevalent in higher quality fixed-income such as Treasury, municipal, and investment-grade corporate bonds.  However, it can still meaningfully impact the junk bond market if the perceived rise in rates is accompanied by a sell-off in stocks. 

More conventional fixed-income benchmarks such as the iShares Core U.S. Aggregate Bond ETF (AGG) peaked by September when interest rates made a significant low.  Conversely, HYG continued to hit new dividend adjusted highs all the way through the first week of 2018.

Despite this relative stability, investors have been reigning in their exposure to junk bonds via these popular ETFs in recent months.  Data from ETF.com indicates that HYG has seen -$2.7 billion in outflows to start the year, while JNK has lost -$3.6 billion.  Those numbers represent a sizeable change in total fund assets and may be driven by expectations of credit spreads widening alongside historical correlations with a downturn in the markets.

High yield investors exiting these ETFs may also have some concerns that the recent fall in energy prices (and energy stocks) will meaningfully impact this sector.  The 2015-2016 decline in commodity prices left a significant dent in the high yield space because of wide-spread selling and credit fears.  It’s worth pointing out that energy makes up less than 10% of the sector allocation within HYG at present.

Those that want the exposure to junk bonds with less credit risk may also opt for exposure to a shorter duration ETF.  Two examples are the PIMCO 0-5 Year High Yield Corporate Bond ETF (HYS) and the iShares 0-5 Year High Yield Corporate Bond ETF (SHYG).  Both funds exhibited shallower dips than HYG during the most recent bout of volatility. 

The Bottom Line

It’s too early to say whether high yield investors have indeed dodged a bullet and the coast is clear to higher highs.  The compression in credit spreads alongside the persistence of interest rates is a worrisome aspect that investors will have to contend with.  Nevertheless, the resilience of this asset class through the month of February is perhaps one bright spot that both stock and bond investors can identify with.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , ETFs , Bonds , Investing Ideas
Referenced Symbols: HYG , SPY , JNK , AGG , HYS , SHYG

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