So far this year high-yield corporate bonds are outperforming investment-grade corporate bonds. The primary reason for this is because central banks around the world are lowering interest rates in order to fight deflation. If you look at this scenario quickly, then you might think that investing in high-yield corporate bonds appears to be a good idea. And while you might be correct, for a while, the devil is in the details.
Central banks are easing in order to fight against deflation. Quantitative easing leads to increased lending, which then helps businesses grow and equities rise. But if interest rates remain low for too long, then overleveraged bubbles occur. (For more, see: Does Quantitative Easing Work?)
High-yield corporate bonds aren’t as sensitive to interest shifts as investment-grade bonds. However, they are sensitive to economic conditions. What’s happening right now is that investors are piling into high-yield corporate bonds because they don’t fear an interest rate hike very much, and because they think the economy is improving. This would lead to increased profits and the improved ability to service debt. Did you notice the contradiction? If central banks are easing to fight deflation then the global economy is not improving. Deflation indicates a decline in prices for goods and services, which stems from declining demand.
It should already be clear that while high-yield corporate bonds and exchange traded fund (ETF) iShares iBoxx $ High Yield Corporate Bond (HYG) have excellent near-term potential, it doesn’t appear to be a wise long-term investment at this juncture. (For more, see: Corporate Bonds: An Introduction to Credit Risk.)
HYG Key Metrics
Purpose: Tracks the Markit iBoxx USD Liquid High Yield Index.
Inception Date: April 4, 2007
Net Assets: $15.25 billion
Average Daily Volume: 7,258,680
Dividend Yield: 5.66%
Expense Ratio: 0.50%
April 2008 High (pre-crash): $99.80
March 2009 Low (bottom): $62.00
Now let's take a look at the SPDR Barclays High Yield Bond ETF (JNK).
JNK Key Metrics
Purpose: Tracks the Barclays High Yield Very Liquid Index.
Inception Date: November 28, 2007
Net Assets: $10.32 billion
Average Daily Volume: 7,724,290
Dividend Yield: 5.96%
Expense Ratio: 0.40%
April 2008 High: $45.97
March 2009 Low: $26.29
It looks as though HYG and JNK are close relatives. But what about the more conservative investor such as one who might prefer iShares 20+ Year Treasury Bond (TLT)? (For more, see: Overview of the TLT ETF.)
TLT Key Metrics
Purpose: Tracks the Barclays U.S. 20+ Year Treasury Bond Index.
Inception Date: July 22, 2002
Net Assets: $7.68 billion
Average Daily Volume: 9,098,020
Dividend Yield: 2.44%
Expense Ratio: 0.15%
April 2008 High: $95.67
March 2009 Low: $100.56
TLT performed much better than HYG and JNK during difficult times. Since its inception, HYG has depreciated 12.50%. Since JNK’s inception, it has depreciated 17.46%. On the other hand, TLT has appreciated 57.17%. (For more, see: Should You Invest with Junk Bond ETFs?.)
The Bottom Line
HYG and JNK are in demand at the moment, but this is based on the premise that the economy is improving. If central banks are easing to fight against deflation, then the economy isn’t improving. Perhaps it can temporarily improve with record low interest rates, but that’s not sustainable. If you’re a gambler, then you might want to consider HYG or JNK. If you’re an investor, consider TLT. (For more, see: Bond ETFs: A Viable Alternative.)
Dan Moskowitz does not have any positions in HYG, JNK or TLT.