Is It Time To Buy High Yield ETFs Again?

February 29, 2016

Masking Inconsistent Yields

First, note that chasing that 9% yield alone can be tricky. Consider that the yield of 9% “masks a tremendous bifurcation in the market,” as Greg Zappin, CFA, managing director and portfolio manager at Penn Mutual Asset Management, put it.

“High-yield credit is really two markets, with a large percentage [yielding] more than 15% and a large percentage trading inside of 6.5%,” he told ETF.com. “There are some company-specific, tactical trades that look attractive in high-yield credit. In general, though, we remain cautious and are not counting on an extended rally in risk markets.”

The reason Zappin remains guarded about this space is that the high-yield market is highly correlated with equities, and both markets have been high correlated with oil prices, he says. It’s correlations, more than default risk, that is keeping him at bay for now.

Equities & Oil Are Key

“You need to have a constructive view on equity markets and oil prices to be bullish on high yield in aggregate,” he said. “Default risk of energy companies is a concern, but largely priced into the market.”

From a technical—and more tactical—perspective, high-yield bond ETFs could prove to be a great short-term opportunity, but not a long-term one, says Steve Blumenthal of CMG Capital Management Group.

“A simple smoothed moving average can tell us a lot about both the short-term and the longer-term trends in high yield: It’s a short-term buy for now, but trading it with stops in place for the overall longer-term trend picture remains less favorable,” Blumenthal said.

Default Risking Rising

“The yield spreads are very attractive; however, default risk is rising,” he said. “Absent recession, high-yield ETFs are attractive given the higher yields created by the recent sell-off. But with a recession—and we will get another recession—we will see defaults rise sharply. That will drive prices meaningfully lower and yields higher.”

Remember that in 2008, we hit 20% yields—levels that we could see again if the U.S. enters a recession, Blumenthal says.

And there’s also the fact that the malaise in high yield doesn’t extend only to energy and oil-linked companies.

Other Sector Funds Stumbling

The latest research from S&P Dow Jones Indices’ Jason Giordano show that high-yield credit default spreads have widened in the past year, but that widening isn’t only due to the trouble in the energy sector.

“The widening also represents the overall discomfort with the amount of leverage companies have on their balance sheets within the broader high-yield market,” Giordano said.

To that point, a look at the latest additions to the list of qualifying constituents for the S&P U.S. Distressed High Yield Corporate Bond Index—a list that has grown “dramatically since August 2014”—shows that these newcomer names aren’t only energy companies; they are also telecom, financial, consumer discretionary and materials names, he notes.

To investors considering getting back into the high-yield segment, Blumenthal has one piece of advice: “Stay tactical.”


Contact Cinthia Murphy at [email protected]

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