Investors Can’t Get Enough Of Junk Bond ETFs

by on August 19, 2010 | Updated August 20, 2010 | ETFs Mentioned:

For investors used to living off of juicy coupon payments from fixed income portfolios, the last several years have been trying times. As central banks around the world slashed benchmark rates to stave off a recession and investors flocked to safe haven investments, yields on high quality fixed income securities have plunged to a fraction of levels prevalent for much of the last decade [see Five Safe Haven ETFs].

Many investors are starved for yield, and unfortunately it looks like the cupboards are still bare. With anxiety over inflation fading fast and the economy still struggling to get onto solid footing, expectations for a rate hike have been pushed far off into the future. The consensus now is that Bernanke & Co. won’t move benchmark rates off of record lows until well into 2011–and perhaps not even until 2012.

With risk aversion still running high, the yields on many of the funds in the Government Bonds ETFdb Category are startlingly low. The 30-day SEC yield on the Barclays 1-3 Year Treasury Bond Fund (SHY) recently dipped below 40 basis points. The comparable yield on longer securities–such as the 7-10 Year Treasury Bond Fund (IEF)–is higher (IEF is currently about 2.4%), but still paltry compared to returns generated in recent years when investors demanded more competitive returns to hold bonds.

With inflation near zero, at least investors don’t have to worry about the return erosion usually presented by CPI increases; the nominal yields on fixed income securities essentially equate to the real return [see ETFs To Guard Against Deflation]. Still, the measly yields offered by the vast majority of fixed income securities have forced investors to step up their hunt for current returns.

Ticker ETF Yield*
SHY 1-3 Year Treasury Bond Fund 0.39%
IEF 7-10 Year Treasury Bond Fund 2.43%
LQD Investment Grade Corporate Bond Fund 4.03%
HYG High Yield Corporate Bond Fund 8.10%
*30 day SEC Yield as of 8/18/10

For many, that search has led to junk bonds.

Demand for corporate bonds that fall below the investment grade cut-off has surged in recent months, as investors are running short on options for asset classes that can deliver an increasingly rare prize: current income. Distribution yields on high yield bond ETFs can tease the double digits, a figure that no doubt jumps out at those depressed by dismal returns on Treasuries and even higher quality corporate debt.

Junk bond sales recently posted a new record, as 26 deals raised more than $14 billion in a single week earlier in August. So far in 2010, more than 350 junk bond issues have raised about $175 billion, almost twice the total from the same period in 2009. ETFs offering exposure to the junk bond corner of the market have also been in high demand; the three ETFs in the High Yield Bonds ETFdb Category saw aggregate inflows of more than $1.5 billion in June and July. Total assets in junk bond ETFs now top $11.5 billion, up nearly 100% from the same period a year earlier.

  • iShares iBoxx High Yield Corporate Bond Fund (HYG): This ETF offers the best diversification for high yield bonds; there are more than 350 individual securities in HYG. Assets in this ETF have soared in recent months, from less than $5.3 billion at the end of July to more than $6.1 billion now.

  • SPDR Barclays High Yield Bond Fund (JNK): Despite maintaining a smaller base of assets, JNK’s average daily trading volume is more than twice that of HYG–perhaps a result of the fund’s memorable ticker. PHB is also the cheapest junk bond ETF, charging an expense ratio of 0.40%. JNK’s assets have also been skyrocketing, growing from $4.3 billion at the end of June to more than $5.2 billion now.

  • PowerShares Fundamental High Yield Corporate Bond Portfolio (PHB): This ETF is based on a fundamental bond benchmark, the RAFI High Yield Bond Index. Assets in this PowerShares fund have climbed from $207 million at the end of June to north of $250 million now.

Disclosure: No positions at time of writing.