High Yield Corp Vs. Bank Loans ETFs

July 15, 2014

Bank loans may be the hot ticket right now, but high-yield corporate bonds are delivering the yields.

When it comes to capturing yield in the corporate debt space, ETF investors are showing a preference this year for senior bank loans over high-yield corporate bonds. That preference, some argue, is largely due to what looks like an overvalued junk corporate bond segment, but it is a choice that has its trade-offs.

In a recent webcast discussing his views on the market, DoubleLine’s Jeff Gundlach pointed out that in 2014, he has opted for bank loans over high-yield corporates for that very reason: overvaluation in the high-yield segment. But as one advisor recently asked, “Is there any asset today that isn’t overvalued?”

The S&P 500 is up 200 percent from its March 2009 lows without serious signs of economic expansion; long-dated Treasurys are at multimonth highs, rallying in tandem with the stock market this year; and riskier fare such as emerging markets are in back in vogue. “Overvalued” could be a relative term these days.

Consider two ETFs as proxy for these separate segments: the iShares iBoxx $ High Yield Corporate Bond ETF (HYG | B-69) and the PowerShares Senior Loan ETF (BKLN | B).

Year-to-date, investors have poured more than $736 million into BKLN, and yanked more than $1.82 billion from HYG. These flows have come despite BKLN’s relatively unimpressive rally of 1.8 percent, while HYG broke through new record-high levels, climbing 4.5 percent in the same period.

HYG_BKLN_YTD_Perf

Chart courtesy of StockCharts.com

HYG has been on a performance roll, benefiting from tightening of credit spreads amid a hunt for yield, even if not evident in the ETF space.

“Credit spreads are approaching pre-crisis levels, but not historical lows,” Howard Lee, ETF analyst at ETF.com, said. “The conventional wisdom is that credit spreads will tighten during an economic recovery and early stage of expansion."

In that environment, Lee says, default risk goes down as companies coming out of a recession are likely to have focused business models and lean structures.

"They’re likely to be profitable and be able to meet payment obligations in a good economy," Lee said. “If one believes we’re still in the early stages of recovery and expansion, then the logic will suggest that spreads will tighten further, leading to lower yields or higher prices.”

From a yield perspective, HYG also has the upper hand, shooting off 12-month trailing yields of 5.7 percent, while BKLN is serving up comparable yields of 4.0 percent.

“In most economic environments, investors do better owning bonds over loans,” Anthony Parish, of Sage Advisors, told ETF.com. “Bonds will greatly out-yield loans over time.”

But it’s easy to understand the appeal of senior bank loans, or a fund like BKLN. The reason you’re paid more for high-yield corporate bonds is because you’re essentially taking on more risk.

 

Find your next ETF

Reset All