The search for yield appears to be drilling into darker and darker corners of the bond market.
Van Eck, the New York-based money management firm that built its reputation in the realm of commodity-related investing, filed regulatory paperwork to market a corporate bond fund of credits issued by U.S. and non-U.S. companies categorized as either defaulted or distressed.
The Market Vectors-Altman Defaulted & Distressed Bond ETF will be based on an index comprising below-investment defaulted bonds and distressed bonds that trade at no less than a 10 percent spread—as measure by “yield to worst”—over a comparable Treasury security. Yield to worst measures the lowest potential yield that can be received on a bond based on the terms of the bond indenture, the filing said.
The planned ETF is the latest example showing that fund sponsors are keen on finding new ways to meet investor demand for securities that produce attractive income now that yields on many kinds of bonds have dropped to such paltry levels since official interest rates were cut to near-zero when financial markets collapsed in 2008.
Everything from dividend-focused equity ETFs to emerging market debt funds to a variety of high-yield debt funds have grown dramatically in popularity. The distressed bond fund is one more variation, and recalls to some extent the Market Vectors Fallen Angel High Yield Bond ETF (NYSEArca: ANGL) that Van Eck rolled out in April of this year targeting credits that started out as investment grade but became junk based on downgrades.
The company didn’t say in the filing what the defaulted and distressed bond fund’s ticker would be or how much its annual expense ratio would be. But it did say that that ETF would have its primary listing on Arca, the New York Stock Exchange’s electronic trading platform.
As of Nov. 2, the date Van Eck filed the prospectus, the index included unspecified percentages of below-investment-grade bonds of issuers from the following countries: Canada, the United Kingdom and the United States.
The company noted in the paperwork that index constituents are capitalization-weighted based on their current amount outstanding, and issuers are capped at 5 percent of the portfolio. However, if this rule becomes hard to apply due to a small number of issuers, then the issuers are equal-weighted within the defaulted bond and/or distressed bond category of the index.
It said the index is a total-return modified market-capitalization-weighted index comprising defaulted bonds and distressed bonds. To be eligible for inclusion in the Index, defaulted bonds must:
- Default as of the 20th day of the prior month
- Have no less than $100 million outstanding
- Be priced by a third-party pricing service for at least the past two prior month-ends
- Be domiciled in the United States or Canada, and denominated in the U.S. dollar
- Have a price at or greater than $0.05 per dollar of original par value
Also, to be eligible for inclusion in the index, distressed bonds must:
- Trade at no less than a 10 percent spread over comparable Treasury securities
- Have no less than $300 million outstanding
- Be priced by a third-party pricing service, for a consistent period of time
Also, the index’s mix of the target allocation between defaulted bonds and distressed bonds will be based on a 12-month trailing “Altman-Kuehne Default Rate.” That default rate measures and monitors the performance of defaulted debt securities and the distressed bank loan market.
The quarterly triggers and monthly target allocations are applied as follows:
- 50 percent defaulted bonds and 50 percent distressed bonds when the default rate is at or below 4 percent
- 65 percent defaulted bonds and 35 percent distressed bonds when the default rate is greater than 4 percent and at or below 7 percent
- 80 percent defaulted bonds and 20 percent distressed bonds when the default rate is more than 7 percent. Rebalancing between the target allocations shall be staggered at 5 percent monthly increments. For example, an index rebalance from 50 percent to 65 percent defaulted securities would take place over three months.
Van Eck said the fund may concentrate its investments in a particular industry or group of industries. As of the date of the filing, the industrials sector and the financial services sector represented a significant portion of the index.