These are trying times for high-yield corporate bonds and rapidly declining oil prices are, once again, a big reason why. In a tumble that started in late October, spanning into the first half of November, oil notched its longest losing streak in 34 years, pressuring speculative-grade corporate bonds along the way.
Oil’s burden on passively managed high-yield bond strategies is easy to understand. The Markit iBoxx USD Liquid High Yield Index and the Bloomberg Barclays High Yield Very Liquid Index allocate about 15 percent of their respective weights to high-yield energy debt.
“American energy companies have been the biggest issuers of high-yield bonds since 2015, according to Dealogic, and their bonds account for about 15 percent of the market,” reports The New York Times. “As the price of crude falls, investors’ concerns about the health of these companies and their ability to pay off the bonds grows.”
An actively managed strategy, such as the JPMorgan Disciplined High Yield ETF (JPHY), can help investors avoid some of the pitfalls associated with passive junk bond funds. A cornerstone of the JPMorgan Disciplined High Yield ETF’s (JPHY) strategy is excluding those bonds that do not exhibit favorable risk/reward characteristics.
JPHY, which debuted just over two years ago as the first fixed income ETF in the JPMorgan Asset Management (JPAM) stable, has been a steady performer since inception. During its just over 26 months on the market, JPHY outperformed a widely followed gauge of investment-grade corporate bonds. The fund also underscores the notion that high-yield bonds can respond positively to rising interest rates as evidenced by JPHY’s significant out-performance of long-dated Treasuries.
Oil And Other Issues
Concerns about oil prices affecting high-yield bonds are credible. When oil prices plunged in 2015, the Markit iBoxx USD Liquid High Yield Index and the Bloomberg Barclays High Yield Very Liquid Index fell an average of almost 6 percent.
Oil prices are not the only issues confounding some high-yield bond investors. Deterioration in CCC-rated debt, bonds just barely above default status, is becoming problematic. Earlier this year, the most speculative bonds led the junk market higher, but that theme came screeching to a halt at the start of the fourth quarter.
By the end of October, CCC-rated bonds saw five months worth of gains go down the drain while higher-rated junk fare outperformed. The possibility of a “CCCrash” is particularly relevant to ETF investors because the Markit iBoxx USD Liquid High Yield Index and the Bloomberg Barclays High Yield Very Liquid Index devote 9.93 percent and 13.30 percent, respectively to the junkiest junk bonds.
As of Oct. 31, 2018, the JPMorgan Disciplined High Yield ETF (JPHY) had no exposure to CCC bonds and 71 percent of its holdings sported the two highest junk ratings.
No Sacrifice Required
It is frequently said that in the world of investing, there are no free lunches. That is true of the high-yield bond space where aiming for higher credit quality can mean taking on more interest rate risk or lower income levels. The JPMorgan Disciplined High Yield ETF (JPHY) does not ask investors to make those sacrifices.
While holding no CCC-rated bonds, JPHY’s 30-day SEC yield of 5.76 percent is just 69 basis points below the yield on the Markit iBoxx USD Liquid High Yield Index and JPHY’s effective duration of 4.39 years compares well with the category average.
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