High-yield ETFs attracting sizable inflows

Oct 26th, 2021 | By | Category: Fixed Income

ETFs providing exposure to high-yield corporate bonds have garnered significant support recently, signaling a notable shift in investors’ risk appetite.

High yield ETFs attracting significant inflows

Higher rates are driving inflows for high-yield bond ETFs.

The $20 billion iShares iBoxx $ High Yield Corporate Bond ETF (HYG US) and $8.7bn SPDR Bloomberg Barclays High Yield Bond ETF (JNK US), the largest ETFs providing broad exposure to the US dollar-denominated high-yield corporate bond market, attracted net inflows of $540 million and $480m, respectively, in the week ending Friday 22 October.

The strong demand marks a change in sentiment with both ETFs previously recording several consecutive months of net outflows over the past year (except for a couple of minor net inflow months for JNK), highlighting how investors have generally avoided the riskier parts of the bond market as the US economy embarks on a volatile post-Covid recovery.

The renewed interest in the segment is likely a reflection of rising rates which have enhanced the relative attractiveness of high-yield bonds compared to their investment-grade counterparts. The Markit iBoxx USD Liquid High Yield Index, which serves as the underlying index for HYG, is yielding 3.97%, as of 22 October, up by nearly 30 basis points since the beginning of September.

Rising rates tend to lead to larger losses for investment-grade bonds compared to high-yield issues as the latter typically have shorter maturities and larger coupons, both of which contribute to lower duration. JNK and HYG have fallen by 0.35% and 0.51%, respectively, since the beginning of September, while the iShares iBoxx $ High Yield Corporate Bond ETF (HYG US) has sunk 1.77% over the same period.

Yields are primarily being driven higher by upwards adjustments to inflation expectations. Higher inflation expectations are also serving to stoke demand for riskier securities that offer yields standing a better chance of providing a positive real return.

Finally, the ongoing rally in US equity markets is serving to increase confidence in high-yield bonds as the equity cushion – the value of a company’s residual market capitalization after subtracting debt and other liabilities – remains significant.

Yet the US economic recovery remains volatile. Just two weeks ago, Goldman Sachs trimmed its forecast for US economic growth in 2021 from 5.7% to 5.6% and adjusted its outlook for next year down from 4.4% to 4.0%, citing an expected decline in fiscal stimulus as well as a slower resurgence of consumer spending due to the effect of the Delta variant.

This dynamic of strong but volatile economic growth is driving demand for a specialized high-yield strategy of investing in so-called ‘fallen angels’, bonds that were originally issued as investment-grade but have since been downgraded to high yield status. In 2020, the market experienced the largest influx of fallen angels in history, driven by the Covid-induced economic downturn.

The $4.6bn iShares Fallen Angels USD Bond ETF (FALN US) has pulled in nearly $1.2bn in net new assets in the week ended 22 October. The fund avoids the riskiest areas of the junk bond market (approximately 90% of the ETF’s assets are allocated to bonds rated BB, the highest rating within high yield), while also currently providing significant exposure to bonds from cyclical sectors that were crippled by the pandemic but potentially stand to benefit the most from the ongoing economic recovery.

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