You Might Not Like The Results, But This Junk Bond ETF Is Behaving As Expected

The iShares iBoxx $ High Yid Corp Bond (ETF) HYG, the largest exchange-traded fund holding high-yield corporate debt, is down nearly 4.5 percent over the past month, so it is not a stretch to say junk bond investors that use ETFs are not enthused by HYG's performance.

However, the ETF is behaving just as expected, and that is important at a time when so many market participants – including some that have an icon status on Wall Street, have questioned the ability of the U.S. high-yield bond market to withstand liquidity events caused by elevated market stress.

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Liquidity, ETFs And Market Stress

Despite all the oft-cited concerns about the liquidity of high-yield bond ETFs during times of elevated market stress, HYG continues to deal with such scenarios with aplomb. According to BlackRock, HYG traded a record $2 billion in the secondary market Wednesday following a day of elevated volume in traditional trading. HYG's secondary market volume soared to $4.3 billion last Friday, according to BlackRock data.

Looking Closer At HYG's Performance

“Trading in iShares HYG surged last week as investors were able to transact directly with one another at known, transparent prices and with ample liquidity,” said BlackRock, Inc. BLK, the world's largest asset manager, in a statement issued Sunday evening.

“HYG delivered $4.3 billion in secondary volume Friday, and $9.8 billion over the course of last week. The vast majority of this trading took place directly between buyers and sellers on exchange, without the underlying bonds needing to change hands. HYG performed as clients have come to expect, as an efficient tool for trading, investing, and price discovery.”

Amid a spate of energy issuer defaults and downbeat performances by CCC-rated issues, tensions are running high in the U.S. junk bond market. HYG allocates 11.4 percent of its weight to energy sector junk bonds, the ETF's fourth-largest sector allocation behind communications, consumer staples and consumer discretionary. A combined 9 percent of the ETF's lineup is rated CCC or CC.

HYG is more than eight and a half years old, so the ETF has endured previous bouts of market drama that have triggered elevated ETF (HYG's volume last Friday was nearly five and half times the trailing 90-day average). However, these instances do not always result in significant departures from the fund.

“HYG's high performance last week builds on prior examples of investors' turning to bond ETFs under market stress – during the 2013 taper tantrum, the 2011 U.S. Treasury downgrade, the 2010 European sovereign crisis, and the 2008 financial crisis after the fall of Lehman Brothers,” said BlackRock.

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“Even with record volumes of $9.8 billion, there was only $560 multi-million of redemptions in HYG – a ratio of 17:1 – for the entire week. This means for every $17 of HYG that traded on exchange, only $1 of high yield bonds was traded to support it. Outflows of this size are not unusual. In fact, HYG saw outflows of similar size three other times this year (May 5, May 6 and June 8). We saw $630 multi-million of outflows on February 3, 2014.”

The secondary market for junk bonds and ETFs like HYG is vital because during times of heightened market stress, over-the-counter high-yield bond market liquidity can and does evaporate, forcing the bulk of trading into the largest, most liquid issues.