Junk Bond ETFs Have Been Resilient...Sort Of

Resiliency may be in the eye of the beholder and the on the surface, it would appear the the iShares iBoxx $ High Yield Corporate Bond ETF HYG and the SPDR Barclays High Yield Bond ETF JNK, the two largest high-yield corporate bond exchange traded funds, have been anything but resilient. However, some data points say otherwise.

Amid a spate of energy issuer defaults and downbeat performances by CCC-rated issues, tensions are running high in the U.S. junk bond market. Add to that, ETFs such as HYG and JNK have been plagued by abundance of issues from the downtrodden energy and materials sectors. Those groups account for the bulk of high-yield defaults this year.

And there has also been substantial increases in trading activity and outflows from junk bond ETFs. Earlier this month, HYG traded a record $2 billion in the secondary market following a day of elevated volume in traditional trading. HYG's secondary market volume soared to $4.3 billion days later, according to BlackRock data. However, some of that volume included, not surprisingly, increased borrows of HYG shares by short sellers. Thing is, those short sellers could be punished if they are not careful.

Related Link: Too Much Of These Sectors Is Hurting Junk Bond ETFs

Noteworthy is the fact that HYG is not deviating wildly from its underlying index, the Markit iBoxx USD Liquid High Yield Index.

“With concerns growing around the US high yield bond market, investors have been fleeing the asset class. Once sturdy in the run up to previous Fed meetings, ETF investors are now shunning high yield bonds amid the growing consensus around the outcome of the December Fed meeting. As a result, some $2.75bn has been pulled from the 24 US listed High Yield ETFs in the past five trading days,” according to a Markit note dated December 17.

Over the past 90 days, HYG and JNK are down an average of 6.5 percent and the duo is off an average of 7.5 percent for the year, though those year-to-date losses were recently in the double digits. Ongoing issues for CCC-rated bonds have caused spreads to widen as bonds with those ratings trade at their highest yield spreads to Treasurys since the financial crisis.

“While these moves appear worrying at first glance, a look at the index's constituent bonds shows that the widening has not been uniform across all sectors, as the proportion of bonds trading at a distressed level (a spread greater than 1,000bps) varies widely across the index,” said Markit.

Markit data notes the bulk of high-yield issues trading at distressed levels hail from, not surprisingly, the natural resources and oil and gas arenas. Twelve industry groups see less than 10 percent of their respective high-yield bond issues trading at distressed levels.