Are High-Yield Bond ETFs Misunderstood?

May 07, 2012

These funds are under scrutiny, but they bring transparency to a traditionally opaque part of the fixed-income market.

 

[This article first appeared on our sister site, IndexUniverse.eu.]

 

So far, 2012 has certainly been the year of the US-listed high yield bond ETF. After pulling in US$7 billion in new flows for the whole of 2011, the sector gathered almost the same amount in the first three months of this year alone, led by the iShares iBoxx $ High Yield Corporate Bond ETF (NYSE Arca: HYG) and State Street’s SPDR Barclays Capital High Yield Bond ETF (NYSE Arca: JNK).

The driving forces behind the flows are well understood. We are in an environment of very low yields, especially for government securities. Investors, particularly those looking to generate income, are challenged in finding investments that generate enough income for their needs. High yield has been a beneficiary of this environment, providing those investors who are comfortable with the credit risk they are taking on with a way to boost income.

All of these inflows into high yield ETFs have rightfully raised some questions about what impact the funds are having on the high yield market. In my opinion, some of the issues are not always broadly understood.

Trading Activity And Market Impact

Some investors look at the size of the flows into high yield ETFs and expect to observe pressure on both fund prices and the underlying bonds themselves. If everyone buys something then its price should go up, right? Despite their growth, ETFs are still a small part of the high yield market. As of a month ago there was US$29 billion invested in US high yield ETFs. That’s less than 3 percent of the US$1 trillion US high yield market.

The combined daily exchange-based trading volume of HYG and JNK is US$447 million, a significant increase over the volumes of just a few years ago, but still a small number when compared to the high yield bond market as a whole, which trades over US$5 billion a day. The total inflows of US$7 billion into high yield ETFs during the first quarter therefore represented less than two days of average trading in the underlying market.

So from a size and trading perspective, high yield ETFs represent just a small percentage of what is happening in the broader high yield universe.

 

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