High yield bonds are finally living up to their name after fixed income markets sold off this year.
Better known as junk, the $1.5 trillion sector looks attractive as yields rose an average of 8.8% from 4.4% at the start of 2022, according to the ICE BofA US High Yield Index. . Junk debt offers an alternative or complement to equities.
Junk bonds are not without risk. The ICE index posted a negative total return of 12.6% in 2022 through last Thursday, although this is better than the 20% drop (including dividends) in the
index. And many investors are understandably reluctant to buy leveraged corporate debt heading into a potential recession.
“Avoid junk bonds and stocks,” warned Ariel Investments portfolio manager Rupal J. Bhansali, a Barrons Panelist, at MarketWatch’s Best Ideas in Money conference on Thursday. “Risk assets” like trash, she said, are not the place to be now.
A counter-argument is that the junk bond math looks pretty good at current levels. The yield gap between junk debt and risk-free Treasuries widened to five percentage points from three points at the start of 2022, based on the ICE index. Now, it would take an 8% default rate, coupled with a bond recovery rate of only 40%, to effectively match the yield on Treasury bills (8% times a 60% loss rate is nearly of 5%, the current spread of junk to Treasuries). Overall, the market seems to be doing well, with a default rate below 1%, although it is likely to increase.
|High Yield Fund / Symbol||Recent Price||Cumulative return since the beginning of the year||Yield*||Assets (bil)|
|iShares iBoxx $ Corporate High Yield / HYG||$73.06||-13.3%||7.7%||$11.1|
|SPDR Bloomberg High Yield Bond / JNK||89.95||-14.2||8.2||5.5|
|VanEck Fallen Angel / ANGL High Yield Bond||26.86||-16.2||6.7||3.0|
|Columbia/INEAX High Yield Bond||$10.25||-12.2%||5.9%||$1.4|
|Vanguard High Yield Corporate / VWEHX||5.10||-11.3||6.6||24.2|
|BlackRock Corporate High Yield / HYT||$8.79||-24.1%||10.5%||$1.2|
|Nuveen Credit Strategies Income / JQC||5.16||-15.3||9.7||0.8|
* 30-day SEC returns for ETFs and open-ended funds; total distribution rate for closed-end funds.
Sources: Bloomberg; business reports
An underrated benefit is that more than half of the market now consists of double-B rated issues, the highest junk rating, from strong companies such as
(AA) and Ford Motor Credit, the automaker’s financial arm. Only 10% of the market is in the most speculative triple C category.
“Most businesses should be able to withstand a mild recession. Companies took advantage of historically low rates to refinance their debt and bloated their balance sheets with cash,” says Dan DeYoung, co-manager of the
Columbia High Yield Bond
funds (INEAX). “Lower interest expense, coupled with lower short-term debt maturities, has given most high-yield companies increased financial flexibility to weather an economic downturn.”
The new issue market is quiet as speculative companies balk at the rates needed to attract investors. Leading financing for the leveraged buyout of a software publisher
(CTXS) was recently done at 10%.
Royal Caribbean Group
(RCL) on Thursday sold $2 billion in debt, including 9.25% in bonds due 2029. Other large pending unwanted deals will fund the buyout of
(TEN). Companies might not like these returns, but investors should.
Investors can play junk bonds through open-ended mutual funds, closed-end or exchange-traded funds, and individual issues. There is also an additional $1.5 trillion in so-called leveraged loans, which are senior bonds issued by individuals and sold to institutional investors. This market also has funds and ETFs.
Many investors like the liquidity of junk ETFs, such as
iShares $ iBoxx High Yield Business
SPDR Bloomberg High Yield Bond
(JNK), which hold some of the largest issues and yield around 8%. The
VanEck Fallen Angel High Yield Bond
ETF (ANGL), which buys corporate debt that was once investment grade, is an alternative that holds bonds from issuers like
Las Vegas Sands
(LVS) and Royal Caribbean. The fund’s performance has outperformed the two largest junk ETFs in recent years.
There is a case for active management in the junk market, where shrewd investors can add value. Closed-end junk funds offer higher returns than open-end funds and ETFs, thanks to leverage, which leads to greater price volatility. “We believe there are great opportunities,” says Eric Boughton, co-director of
Matisse Discounted Bond CEF Strategy
(MDFIX), which buys discounted closed-end bond funds in many sectors, including junk and municipalities.
He says junk returns are attractive and closed-end funds are a cheap way to play the industry, as the average fund discount to net asset value is 9%, down from 5% over the past two years. last years.
BlackRock Corporate High Yield
(HYT), the largest junk closed-end fund at $1.2 billion, trades around $9 per share, a 9% discount to net asset value. It pays more than 10%.
Nuveen Credit Strategies Income
(JQC), which buys leveraged loans, is trading around $5, a 14% discount to NAV, while yielding 9.5%.
Closed-end leveraged funds have negative returns in the teens this year, but if the market rallies, they could rise smartly.
Even individual bonds look attractive. Columbia’s DeYoung has a soft spot for debt
American Airlines Group
(UBER). He favors a US $3.5 billion issue backed by his AAdvantage program. These 5.5% bonds due in 2026 now yield 8%. DeYoung says they’re safe, given the value of the mileage program and its importance to American. Uber, the big ride-sharing company, was profitable by a measure in the second quarter, sending its stock up more than 30%. Its 4.5% bonds due 2029 yield about 7%.
It is not easy for retail investors to buy individual junk bonds, as many of them are issued as private placements under Rule 144A and are only available to institutions (purchasers retail can purchase certain transactions).
Barrons wrote about the high yields of “bust” convertible bonds, often issued by once-popular growth companies, such as
(MSTR). These trade at significant discounts to their face value and pay yields to maturity of 10% or more. Peloton’s zero-coupon convertible due 2026 is trading at 67 cents on the dollar and yielding 12%, while Wayfair’s 0.625% issue due 2025 is trading at 70 cents and yielding over 12%.
Owner MicroStrategy’s zero-coupon bond, due 2027, trades at less than 50 cents on the dollar and yields 18%. Most convertibles lack ratings and would likely be of junk quality if they had any.
There are now plenty of choices in the junk food market.
Write to Andrew Bary at [email protected]