Buying Opportunity In Junk Bond ETFs

August 28, 2015

The financial market turmoil of the past week has had many victims. From stocks to commodities, there haven't been many areas immune to the recent selling.

However, the bond market has seen real resilience. U.S. Treasurys—considered the ultimate safe haven by many—rallied solidly during the past few weeks, while U.S. investment-grade corporate bonds held steady in that period.

While the higher-quality areas of the bond market have weathered the latest bout of risk aversion, riskier bonds haven't fared so well. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG | B-64), the giant in the space, having $12 billion in assets, hit its lowest price since 2011 earlier this week.

The price decline in high-yield bond funds lifted the yield for HYG and similar ETFs to their highest levels since 2012. Based on current prices, HYG has a juicy yield-to-maturity of 7 percent. Is now the time to buy, or is there more downside in store?

Junk Bond Yields

Source: Barclays

Tied To The Economy

In general, high-yield corporate bonds―also known colloquially as junk bonds―perform poorly when concerns about the economy intensify. Issued by companies on the riskier end of the spectrum, the default rate for these bonds is already higher than investment-grade bonds, and that rate naturally increases during tough economic times.

In recent years as the economy has recovered, defaults have been rare. According to Moody's, the U.S. speculative-grade default rate during 2014 hit a six-year low of 1.7 percent. That pressured the spread between junk bonds and safe-haven 10-year Treasurys to as low as 2.2 percent in 2014, based on data from Barclays.

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