High-Yield Bond ETFs Are Hot Again

The Materials Select Sector SPDR XLB and the Energy Select Sector SPDR XLE are up 1.8 percent and 2.5 percent, respectively, year-to-date. While those gains are not jaw-dropping, they are enough to put those once moribund sectors in rebound territory.

Rebounding and energy materials names are one thing. Comebacks for those credits is a different story and that story is being played with investors' renewed enthusiasm for high-yield corporate bond exchange traded funds, such as the iShares iBoxx $ High Yield Corporate Bond ETF HYG and the SPDR Barclays High Yield Bond ETF JNK.

Previously, the energy and materials sectors were drains on HYG and JNK, the two largest junk bond ETFs, other high-yield corporates ETFs. Amid a spate of energy issuer defaults and downbeat performances by CCC-rated issues, HYG and JNK were pressured last year. Compounding that problem was the fact that there is plenty of supply in the high-yield market from energy and materials issuers.

But 2016 is a new year and investors are once again embracing junk bond ETFs.

“Investors have been keen to take advantage of the improving macroeconomic backdrop by taking on risk through HY ETFs, due to their relative liquidity and ease to access. The last five weeks have seen consecutive inflows totalling $6.1bn, reminiscent of the inflows seen last October as global credit markets rallied on diminishing fears over a China/emerging markets slowdown,” said Markit in a new note.

Year-to-date, HYG and JNK have added $1.58 billion and $2 billion, respectively, in new assets. JNK's haul puts it among the top 10 asset-gathering ETFs this year. The energy rally is helping. HYG devotes just over 10 percent of its weight to bonds hailing from that sector.

In what could be seen as good news, in a strange world, the dollar amount of energy and materials junk bonds floating around today is off its highs.

"According to Markit’s iBoxx indices, the sector leading the recent rally in US HY bonds has been Oil & Gas, which has seen spreads fall 547bps since February 11^th. This comes as no surprise given crude oil’s rebound, but spreads remain above 1,000bps, indicating distressed levels. Basic Materials has seen a 388bps tightening and average spreads are back below 1,000bps. While these two sectors have led the tightening in absolute terms, both represent around a fall in spreads by around a third, similar to the Utilities and Financials sectors, implying a broad based tightening,” adds Markit.