Despite Risks, Investors Flock To Junk Bond ETFs

Perhaps heartened by oil prices that look better relative to what was seen last year, and the Federal Reserve slacking off on raising interest rates, fixed income investors are embracing high-yield corporate bond exchange-traded funds.

Those investors are doing so with ETFs that sport longer durations, indicating they believe it will be a while before the Fed gets around to boosting borrowing costs. For example, the iShares iBoxx $ High Yid Corp Bond (ETF) HYG and the SPDR Barclays Capital High Yield Bnd ETF JNK, the two largest junk bond ETFs, have added $1.65 billion and $2.44 billion, respectively, in new assets this year.

While U.S. government bond ETFs are the apples of fixed income investors' eyes this year, the aforementioned data suggest investors are not skirting junk, either.

Is It Junk, Or Hidden Treasure?

“While the majority of the inflows have been aimed at products that invest in government bonds, a small but growing portion of inflows have ended up in corporate bond funds which tend to invest in investment grade debt with a maturity greater than ten years. These bonds tend to offer a relatively higher yield than the average investment grade bonds; 0.61 percent more for EUR denominated investment grade and 0.79 percent for USD debt, but also come with the increased risk linked to their longer maturity,” said Markit in a research note.

HYG and JNK have an average duration of just over four years, which is not exceptionally high, but investors' affinity for these products when there are lower duration alternatives on the market, says some just are not worried about rising interest rates.

Maybe what buyers of these ETFs and others should be concerned about is rising default rates. Junk default rates are the highest they have been in six years and nearly 4 percent of issuers of such debt defaulted over the past year.

Piqued Interest

Other data suggest the population of the junk bond universe is on the rise as some bonds that previously had investment-grade ratings fall to high-yield status.

“To this end, the portion of BBB rated bonds in the Markit iBoxx $ Corporates 10Y+ index, the lowest rung in the investment grade ladder, has grown to 47 percent over the last five years from 41 percent in March of 2011,” added Markit.

JNK, with a 30-day SEC yield of almost 7.2 percent, allocates over 83 percent of its combined weight to BB or B-rated issues.

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