Is It Time To Buy High Yield ETFs Again?

February 29, 2016

High-yield bond ETFs went through the grinder late last year, dropping to multiyear lows as fears about widespread defaults—linked largely to the decline in oil prices—mounted. But in recent days, they seem to have found a footing, or at least enough of one to fuel the question: Is it time to get back into this segment?

UBS’ call last fall for default rates to possibly double by the third quarter of 2016 is still reverberating among investors. If UBS is right, defaults in high yield—led by energy, metals, mining and commodity companies in general—could hit 4.8% by Q3, up from 2.6% last September, and from 1.6% in September 2014, according to Bloomberg. That’s a red flag.

Sounding Alarms

Money managers such as Jeffrey Gundlach have long been warning about the dangers of high-yield bonds, calling junk bond funds possibly one of the worst investments an investor could make right now. His views aren’t new—he’s been tooting this horn for months now—but he recently reinforced them in a panel discussion, as reported by Forbes.

To people like Gundlach, owning ETFs such as the SPDR Barclays High Yield Bond ETF (JNK | B-68) and the iShares iBoxx USD High Yield Bond Corporate ETF (HYG | B-68) carries a lot risk at the moment with not enough reward.

But what if default rates don’t increase? JNK and HYG are shelling out 30-day yield of about 8-9%, levels that aren’t only historically high, they are recessionarylike levels. If the U.S. economy doesn’t sink into a recession, and default rates don’t jump—as some fear—high-yield bonds could in fact be very cheap and attractive.

Battered Bond ETFs Rising

In the past month, HYG and JNK both dipped to their lowest levels since mid-2012, but managed to bounce off, and have been on the rise since. Both funds are now in the black for the past 30 days, as the chart below shows:

Chart courtesy of StockCharts.com

In the month of February alone, investors have poured nearly $600 million of fresh net assets into HYG, and some $263 million into JNK. Flows into both funds are net positive so far for 2016. That’s a clear turnaround from the action we saw in late 2015 when JNK bled $1.7 billion in two months, and HYG faced $165 million in net redemptions.

There are a few things investors should consider if thinking about getting back into this segment.

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