Bond ETF Bad Boys Try To Bounce Back

The iShares iBoxx $ High Yield Corporate Bond ETF HYG and the SPDR Barclays High Yield Bond ETF JNK, the two largest high-yield corporate bond exchange traded funds, were bond bad boys last year, losing an average of almost six percent.

However, HYG and JNK added $1.6 billion and $1 billion, respectively, in new assets last year as falling oil prices, interest rates and the erosion CCC-rated debt took tolls on high-yield corporate bonds.

Even with plenty of controversy surrounding junk bonds, investors continue embracing the asset class even as ETFs like HYG and JNK are struggling in 2016.

“Embroiled in weakening commodity prices, a concern over global growth and bouts of idiosyncratic risk, US HY bonds, as represented by the Markit iBoxx $ Liquid High Yield Index have seen negative returns for seven of the last eight months. This month however, there has been a recovery of sorts, with the index being down as much as 4.15% on February 11^th, before regaining over 3%, to -0.96% as of February 22,” said Markit in a new note. 

As oil prices have modestly recovered this year, the spreads between junk and investment-grade corporate debt have narrowed a bit. However, that theme is vulnerable as members of the Organization of Petroleum Countries (OPEC) and other major oil-producing countries are proving reluctant to scale back production.

Some investors remain concerned about junk bond liquidity, indicating that size is a concern as well. Home to a combined $22.2 billion in assets under management, HYG and JNK certainly pass the size test, but what is more important is the size and subsequent liquidity of the ETFs' underlying holdings. A recent study by Fitch Ratings confirms that an issue's size and ratings were pivotal factors in determining junk bond liquidity.

When junk bond ETF volume soared in December, the secondary market efficiently absorbed increased turnover in HYG. 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.

“Since the beginning of February $734m has exited ETFs tracking US HY bonds, on course to be the fifth month out of the last seven to see outflows. But this figure could have been higher; the past week has seen $1bn of inflows into US HY ETFs according to Markit’s ETP service, recouping the much of this month’s outflows,” adds Markit.

Year-to-date, HYG has lost assets while JNK has seen inflows of nearly $120 million.