Bonds: High Yield
According to a July survey conducted by VettaFi and State Street Global Advisors, high yield credit strategies were the bond style most appealing for advisors to add to client portfolios. With treasury yields narrowing and the Federal Reserve aggressively hiking rates to tackle inflation, investors are looking to take on more credit risk to receive higher yields. This is evident as three top high yield corporate bond ETFs, that collectively manage $44 billion, pulled in $4.7 billion in flows during July. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) brought $1.9 billion in new assets during July, while the SPDR Bloomberg High Yield Bond ETF (JNK) and the iShares Broad USD High Yield Corporate Bond ETF (USHY) brought in $1.7 billion and $1.1 billion, respectively. It appears that investors currently prefer high yield bond ETFs with higher risk profiles to funds that offer more protection against rising rates.
Finsum: Due to the Fed’s rising rates policy and narrowing yields, investors flocked to high-yield bond ETFs last month.
Fixed-income investors are looking for an out of rising yields and lower bond prices, and junk bonds might be the place for income investors to find relief. According to BlackRock, the underlying credit risk is much lower than the market is assuming, because high-yield issuers actually have strong stable balance sheets. BR and KKKR & Co. Inc. are purchasing more junk bonds and similar market segments given their relative value. While they do expect market conditions to tighten they do not anticipate an unusually high default rate. Investors should be weary of additional volatility that could be induced by macro factors moving forward.
Finsum: If a bond market crisis hits high yield debt due to a full-blown recession, the Fed would most likely roll back the tightening currently taking place.
Pick your favorite recession signal and there is a chance it's flashing the warning signs. Most are eyeing the 2-to-10 year yield curve which inverted in early April. Investors worried about the recession should turn to high-yield bonds, but specifically, those ‘sin’ goods are the best remedy for the recession. Alcohol and Tobacco are two of the best performing industries in the 12-months leading to a recession and the years after. Food and beverage, utilities, and healthcare all are great performers as well. The high yield bonds to avoid are telecommunications and retail shopping, as their returns can vary drastically.
Finsum: Junk bond yields are relatively high right now and less sensitive to Fed moves, high yield bonds are a potentially good alternative right now.
If the treasury market isn’t upside down it’s certainly moving there. Yields are rising which means prices are falling. The worst part is with inflation picking up there is a lot of room to move in longer-term treasury bonds. So where should investors turn to? Fallen angel bonds and their associated funds. Fallen angels are investment-grade bonds that have been recently downgraded to junk status. The biggest benefactor is that these relatively riskier bonds have a way higher return but there is less interest rate pass-through. That means as the Fed begins to strangle the government bond market the lower-grade corporate bonds won’t feel much of the pain. Many of these corporations have relatively strong balance sheets and the risk is overblown, so profits can recover quickly.
FINSUM: The fallen angel fixed income ETF market has an incredible yield advantage, and there is so much fiscal and monetary support that the risk is probably smaller than the yields are saying.
The overall bond market is almost a bust this year but investors flocking for a yield can only go to one place, junk bonds. Lending conditions are very loose with all the accommodations both fiscal and monetary policy made this year, and those attempting to stream any income have to learn to high-yield debt. Inflation is eating up anything to be gained in treasuries. Investors are now treating high yield debt like a more liquid asset than ever purely because traditional bonds are losing to inflation. All of the policy measures have made many feel corporate debt is less risky than ever but the excess demand may be tipping, as even some of the riskiest debt is being sought after. Still high nominal economic growth is good for borrowers and reduces to investors.
FINSUM: Investors should be aware of interest rates pass-through from Fed tightening to corporate debt, strong inflation could lead to weaker pass through and even lower spreads than the market is already seeing.
By any reasonable measure, high yield bond markets look very scary right now. The way that yields have plummeted, the way that covenants have weakened, and the general ease of accessing credit are all reminiscent of 2005. Spreads over Treasuries have fallen to just 300 bp. A year ago they were at 600 bp. Companies have successfully weakened investor protections in new issues without penalty, and crucially, default rates will likely fall below 1% this year. The picture was the same in 2005.
FINSUM: By the Crisis, default rates hit 14% and high yield investors got killed. However, a big correction in high yield would take a catalyst. Is it a sooner-than-expected Fed pullback?