In a high-yield market that may be vulnerable, it makes sense to look beyond ETFs.
This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by K. Sean Clark, CFA, chief investment officer of Philadelphia-based Clark Capital Management.
It's not easy for bond investors these days.
Let's face it: The yields of government paper aren't too exciting.
We know that with interest rates hovering near record lows—not just here in the U.S., but globally—investors and advisors alike have moved down the credit scale to junk bonds and emerging market debt in search of yield.
Over the past few years, assets flooded into high-yield bonds, and it has become a crowded trade. It makes me think that while high-yield bond ETFs have their place in a diversified portfolio, investors would be wise to look beyond high-yield ETFs to get diversified high-yield exposure.
But first, let's look more closely at what's going on in the world of high-yield debt.
| Global 10-Year Bond Yields - As Of 7/31/14 | |
| United States | 2.55% |
| United Kingdom | 2.60% |
| France | 1.53% |
| Germany | 1.15% |
| Italy | 2.70% |
| Spain | 2.50% |
| Japan | 0.53% |
| Australia | 3.50% |
Source: Bloomberg
The Federal Reserve stimulus policies have artificially kept interest rates extremely low, skewing the traditional metrics used for valuing assets. This, in turn, appears responsible for creating a speculative environment in which most of the stimulus found its way to the investment markets and not the real economy.
Companies have been able to easily get financing or to refinance existing debt at lower rates. The U.S. high-yield debt market has exploded to more than $1.2 trillion, and the global high-yield marketplace currently stands at more than $2 trillion, up from just $1 trillion in 2009.
Although the high-yield market has exploded and the amount of outstanding debt has soared, dealer inventories have plummeted. I believe this is the result of regulations adopted since the credit crisis that resulted in shrinking dealer inventory. We feel an unintended consequence of the regulations is that dealers may not be there to backstop the marketplace if and when selling accelerates.
For example, the Dodd-Frank Act pushed dealers to change their business models, and that could have a meaningful impact on the marketplace when liquidity is needed the most. The concern is that bids could drop precipitously without natural buyers of the bonds.
The high-yield market has been under pressure over the past few weeks, but it's not likely to be related to the above concerns. High-yield benchmarks peaked in early July. For example, the Barclays High Yield Index peaked on July 7 and lost 1.57 percent through Aug. 5.
Those losses are manageable and still within the context of normal market volatility. Since the credit crisis ended in 2009, there have been at least five other instances where the high-yield market has corrected more than it has currently. Those include:
- -5.18 percent around Bernanke's taper talk
- -2.73 percent in May 2012
- -9.48 percent during the debt crisis in summer of 2011
- -4.67 percent in May 2010
- -2.82 percent in January 2010
