High-Yield Bonds: Are They Junk or in a Sweet Spot?
Financial advisors can track this market with ETFs.
How familiar you are with high-yield bonds as a potential investment might depend on whether you’ve ever heard of Michael Milken and Ivan Boesky.
Those two were at the center of one of the biggest financial bubbles and busts of the 1980s. Fast-forward to today, and what was known back then as the “junk bond” market has transformed into a market segment more commonly referred to now as “high-yield bonds.”
Part of that is due to generally higher-quality companies that make up this group of corporate bonds rated below BBB. That is, from BB and B on down. High-yield bonds are now a $1.35 trillion asset class.
Tipping Point for High Yields
Still, the high-yield market is at a potential tipping point. Spreads, the percentage by which these bonds exceed that of a comparable U.S. Treasury bond, have started to creep up over the past three weeks. In the case of B-rated bonds, that increase in spread has been from 3.8% to 4.4%. High-yield investors can decide that this means they are cheap or that they’re falling apart. The former would be the view of those who believe that the economy will avoid recession, and that rates will at least stay stable at these levels or fall.
The bearish view on high yield would likely relate to the approaching corporate bond "maturity wall." In 2024 and 2025, an historically high amount of corporate bonds will come due. Given that many issuers of high-yield bonds tend to have a mediocre financial position, replacing lower yields from past years with today’s higher yields is a daunting prospect for many companies.
How big is the wall? High-yield maturities are projected to more than double in 2024 versus this year, and 2025’s total is more than 50% above that of 2024.
As with any other asset class-related decision, investment advisors can count on two things:
- Different client situations will require different allocations if high yield bonds are even in the discussion.
- ETFs are ready and waiting to implement the strategy, whether bullish, bearish, or in between.
High Yields and ETFs
Our ETF screener identifies 103 ETFs in the high-yield category. The largest is the $12.9 billion iShares iBoxx USD High Yield Corporate Bond ETF (HYG).
How mission-critical is this ETF to the high-yield market? Back in 2020, when the Federal Reserve determined the bond market needed massive support amid the pandemic’s impact on markets, it bought over $600 million worth of HYG. This is in line with how investors, apart from some large institutions, are using ETFs as a liquid way to position, temporarily or longer term, in this asset class.
HYG’s duration is a modest 3.4 years. But for those who prefer putting their high-yield bond allocation on a shorter leash, ETFs like the PIMCO 0-5 Year High Yield Corporate Bond Index ETF (HYS), a $1.18 billion fund, sports a duration of only 2.2 years, and spreads its holdings across more than 700 bonds.
Then, there’s the other end of the spectrum. For those who seek to profit from a future decline in the fortunes of the high-yield sector, the ProShares Short High Yield ETF (SJB) delivers the opposite return of the index HYG is based on.
As with any inverse ETF, advisors and investors should familiarize themselves with the nuances of these funds, particularly the fact that their goal is to replicate the inverse return daily. Over long periods of time, the associated performance math can create a different return stream than simply the opposite of HYG.
High yield or still just junk? That’s a timely question for advisors and investors to consider, as we approach an interesting part of the investment cycle.