Not everyone’s a winner when oil prices collapse.
If you’ve been reading headlines lately, you’ve probably caught a note of panic among followers of high-yield bonds, capped by this lovely headline at Business Insider yesterday:
I give the headline points for clarity, but demerits for economy. Still, there is a bit of a panic going on in the junk bond world, and for good reason. Energy companies have traditionally been big users of the debt markets, and while of course huge diversified companies don’t often end up in the junk bond funds, plenty of smaller, more speculative companies do.
In many ways, the energy sector, like telecommunications, is the poster child for why the junk bond market exists in the first place. Companies like Antero Resources use the bond markets to raise cash to go drill new wells, just like small telcos use the bond market to raise cash to string new fiber. It’s classic infrastructure investment.
Because of that, those two sectors are big factors in most junk bond indexes, and while nothing all that special is hitting the telcos, we all know what’s been going on with oil.
Where Are The Risks?
So how does this impact junk bond ETFs? The iShares iBoxx $ High Yield Corporate Bond ETF (HYG | B-66), for instance, has roughly a 15 percent exposure to energy. Our Analyst Pick SPDR Barclays High Yield Bond ETF (JNK | B-68) has more than 17 percent in energy. And since both ETFs follow indexes that eventually try and mirror the market for available debt, their exposure to energy is likely to increase, as this year was the largest in a long time for energy junk-bond issuance. Some analysts have it as high as 19 percent of all new paper that’s hit the street in 2014.
As investors get nervous about the prospects for these less-than-investment-grade energy companies, they are, as you expect, demanding higher and higher yields for their money, which means prices have come down. That’s put a real drag on performance recently, with both funds giving back most of their yield for the year due to falling prices: