Since late last summer, high-yield corporates and high-yield munis have moved practically in opposite directions—a move that’s not often seen.
Consider the chart below, plotting the performance of the two biggest high-yield muni ETFs, the $2 billion Market Vectors High-Yield Municipal (HYD | C-59) and the $415 million SPDR Nuveen S&P High Yield Municipal Bond (HYMB | C-59), and the two biggest high-yield corporate bond ETFs, the $17 billion iShares iBoxx $ High Yield Corporate Bond (HYG | B-68) and the $12 billion SPDR Barclays High Yield Bond (JNK | C-68):
Chart courtesy of StockCharts.com
This divergence has “nothing to do with ratings, but everything to do with the perception of creditworthiness,” according to John Mousseau of Cumberland Advisors.
In the case of high-yield corporate bonds—HYG and JNK—pressure has largely stemmed from the drop in oil prices, and an expected rise in default rates largely linked to the energy sector. There’s also the concern that companies issued a lot of credit in recent years due to low rates, and chances are that some of these low-quality credits might default.
Higher-than-expected correlations with the equity market has also impacted the attractiveness of this segment lately.
Munis, meanwhile, are directly linked to what happens in interest rates. As Mousseau puts it, “Think corporate and you're thinking corporate ‘IOU.’ With munis, you have liens and pledges and much more security.”
“The high-yield muni is responding pretty much to interest rate movements, and the high-yield corporate market to credit movements and concerns,” Mousseau added.
From a fundamental perspective, while junk corporates battle the fears of default, junk munis are also benefiting from generalized improvement in municipalities’ overall tax receipts and the ongoing refinancing of coupon bonds in the current rate environment, Mousseau says.
Junk munis have even been buoyed by the recent tax season as investors look to minimize taxes for the following year—munis are tax exempt—and capture income at the same time.
“The market is perceiving the muni market’s creditworthiness as second only to Treasurys,” Mousseau said.
Since the Federal Reserve hiked rates last December, it has been signaling a more dovish tone, fueling expectations that rates will remain unchanged the remainder of this year.
Even if interest rates rise, munis should offer enough of a yield cushion to buffer a performance slip. And that yield cushion is tax exempt.
HYD, which tracks a market-weighted index of high-yield long-term tax-exempt municipal bonds, is shelling out yield to maturity of 5.2%. HYMB, where about 40% of the portfolio is investment grade, is delivering 5.0% in yield to maturity, according to FactSet data.
Contact Cinthia Murphy at [email protected].