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  1. Active ETF Channel
  2. Why Some Advisors Are Buying the Junkiest Junk Bonds
Active ETF Channel
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Why Some Advisors Are Buying the Junkiest Junk Bonds

Tom LydonJun 16, 2021
2021-06-16

The Markit iBoxx USD Liquid High Yield Index, a widely observed basket of high-yield corporate debt, is basically flat this year, and with credit spread narrowing, some active high-yield bond managers are reaching into the depths of the asset class to generate returns.

Credit spreads measure the added yield an investor receives for taking on credit risk in excess of U.S. government debt. Narrowing spreads can imply that the investor isn’t being adequately compensated for the risk associated with junk bonds. A byproduct of those condensing spreads is that some managers are reaching into CCC territory where default risk dramatically rises.

“The global corporate annual default rate for issuers rated BB was 0.93% last year, compared with 3.5% for issuers rated B and a whopping 47.5% for issuers rated CCC, CC, and C,” writes Morningstar analyst R.J. D’Ancona. “This phenomenon contributes to the persistent compensation (yield) differences offered at each rating tier, which is particularly acute during times of credit market stress.”

Data suggest that overall default rates among junk issuers are likely to be lower than expected year, and that could be one reason why active bond managers are embracing the riskiest debt in this asset class. As D’Ancona notes, the average high-yield bond fund rated by Morningstar saw its CCC allocation jump to 12.8% in March from 10% in December 2019. The aforementioned Markit iBoxx USD Liquid High Yield Index allocates 11.24% of its weight to CCC and CC bonds.

“These figures reflect the general trend, but if we drill more deeply, we see that some active fund managers are making much bolder bets,” said the analyst.

While the economy is firming and default rates are likely to be benign, investors willing to embrace CCC bonds may do well to embrace active management rather buying individual issues.

Among well-known fund issuers, T. Rowe Price recently filed plans for three active bond ETFs – the T. Rowe Price Total Return ETF, T. Rowe Price QM U.S. Bond ETF, and T. Rowe Price Ultra-Short Term Bond ETF. Those funds could potentially feature some high-yield exposure, though it’s not yet clear how far down the credit rating spectrum managers will go.

For more news, information, and strategy, visit the Active ETF Channel.

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