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Junk Bond ETFs Keep on Trucking

Another one of the more prominent themes among bond ETFs last year was growing speculation that high-yield bonds were approaching bubble territory. Calls for asset bubbles is an old investing avocation, and since the global financial crisis, it seems that every time an asset class’s popularity rises too quick for the comfort of some, a bubble must be right around the corner.

Talk of a junk bond bubble seemed to start in earnest in the second quarter of 2012, prompting a spate of coverage of the topic. Later in the year, there were reports of redemptions from popular junk bond ETFs such as the iShares iBoxx $ High Yid Corp Bond (NYSEARCA:HYG).

iShares Dow Jones US Home Const. (ETF) (NYSEARCA:ITB)

Those reports may have fueled the fire of the junk bond bubble prediction, but most mainstream media coverage of the issue ignored the fact that while iShares iBoxx $ High Yid Corp Bond (NYSEARCA:HYG) saw some modest outflows here and there, some other new high-yield bond ETFs became home to soaring inflows.

In other words, some important points about the efficacy of a junk bond bubble in the current environment are being missed, according to Market Vectors Portfolio Manager Fran Rodilosso.

“I think there is a difference so far between what we are seeing at the beginning of 2013 and the types of credit bubbles we have seen historically,” said Rodilosso. “A bubble is built on excessive leverage, and modern bubbles have been fueled by leveraged buyouts, real estate speculation, and structured products with a high degree of embedded leverage.”

While 2013 is still young, investors to this point, have scoffed at talk of junk bond bubble, sending major high-yield bond ETFs modestly higher to start the new year. iShares iBoxx $ High Yid Corp Bond (NYSEARCA:HYG), the largest junk bond ETF by assets, is 0.7 percent to start the new year while its primary rival, the SPDR Barclays Capital High Yield Bnd (NYSEARCA:JNK) has gained 0.1 percent.

Noteworthy is the fact that the SPDR Series Trust (NYSEARCA:SJNK), JNK’s short duration equivalent, now has almost $668.6 million in assets under management, according to State Street data. That is up from $518.7 million on December 4.

Clearly, quantitative easing, which has depressed yields on U.S. Treasuries, has contributed to a yield chase. However, as Rodilosso notes, credit spreads between junk bonds and Treasuries are not at concerning levels.

“Yields have been pushed down by a highly aggressive central bank policy, with the result that yield-oriented investors have been pushed into owning lower-rated credits,” said Rodilosso. “As a result, the yields on riskier debt are as low as they have been. But the credit spreads, the difference between the yield on high yield bond and a Treasury security, are actually closer to their historic average.”

One issue that may be fueling the junk bubble chatter is new issuance, which rose to an all-time high of $306 billion through the end of October.

In years past, that might have implied increased leveraged buyout activity or companies using debt to fund dividends, but Rodilosso highlights a different possibility.

“Whereas during a more ‘classic’ bubble a vast majority of debut issuance has historically funded takeovers, dividends, and massive capital spending, 2012’s record issuance was still, for the most part done for the purpose of refinancing. That refinancing was done at lower interest rates, reducing the cost of debt for many borrowers, while reducing the amount to be paid back over the next two years.”

Rodilosso oversees $1.4 billion in assets across several Market Vectors ETFs, including the Market Vectors ETF Trust (NYSEARCA:ANGL) and the Market Vectors Emerging Mkts Local (NYSEARCA:EMLC).

This article was originally written by The ETF Professor, and posted on Benzinga.

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