High Yield Bond ETFs Have Hit A Plateau

The high yield bond market has continued to reap the benefits of low interest rates and a hunger for yield that has fixed-income investors climbing down the credit ladder.  This healthy demand has helped push prices in many junk bond ETFs to all-time highs, which in turn has pressed yields near historical lows.

The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) is the largest ETF in this space with more than $13.7 billion in total assets.  This fund invests in 940 individual bonds of companies with below investment grade credit quality and charges an annual expense ratio of 0.50 percent. 

So far this year, HYG has gained 4.87 percent in total return and is currently sporting a 30-day SEC yield of 4.19 percent.  When you consider the 12-month trailing distribution rate on HYG is listed at 5.69 percent, you can see just how far the yield has fallen on this ETF over the last year as the price continues to defy gravity.    

Despite this strong historical momentum, recent sluggish price action may point to HYG and similar ETFs such as theSPDR Barclays High Yield Bond ETF (JNK) hitting a temporary plateau.

This may be the result of investors pulling back their appetite for risk and re-allocating to other income opportunities such as REITs, MLPs, and preferred stocks which have all had much stronger returns in 2014. 

Another interesting phenomenon is watching asset flows in this space.  So far this year, HYG has lost more than $1.6 billion in total assets, while short-duration funds have seen strong inflows.  The PIMCO 0-5 Year High Yield Bond ETF (HYS) and SPDR Barclays Short Term High Yield Bond (SJNK) have experienced combined growth in assets of $2.8 billion in 2014. 

The lower duration of these ETFs make them less sensitive to changes in interest rates, which may be a rotation strategy to shelter high yield portfolios from the risk of rising rates.

Many fixed-income experts have been concerned with the level of complacency in high yield bonds over the last several years and worry about the volatility that can expand if credit markets contract.  Virtually any sign of stock market weakness or economic instability could impact this high yield sector in a negative manner.

Despite these risks, high yield bonds continue to produce a level of income that many investors can’t replace in this low interest rate environment.  For that reason, they may continue to see strong demand for the foreseeable future.