By ETF Heat Map Team
Junk bonds have been an attractive investment for risk seeking investors looking for high yielding assets. We often associate risk with return i.e. the higher the risk, the higher the potential for return, and given the Federal Reserve’s policies, many investors have been chasing higher yielding assets. However, as we approach the Federal Reserve’s upcoming September meeting, there appears to be increased put activity (according to CBOE / Nasdaq data) on certain Junk Bond ETFs. Specifically, iShares iBoxx High Yield Corporate Bond ETF and others, appears poised to be a hedge for traders and investors looking to mitigate their downside.
iShares iBoxx High Yield Corporate Bond ETF has gained approximately 12% YTD and approximately 66% since inception. It has a 30 SEC yield of approximately 5.5%, effective duration of approximately 4 years and a 0.50% expense ratio. However, many investors have been turning bearish according to according to estimates from financial analytics firm S3 Partners. Ihor Dusaniwsky, head of research at S3, suggested that “shorts continued to build their positions as the probability of a fed funds rate increase diminished”.
Furthermore, in the volatile market conditions currently present, the possible default risk and risk of repayment associated with certain issuers requires a great deal of due diligence. S&P indicates that junk bonds’ default rate has been rising, currently estimated at 4.8% and expected to rise to 5.6%. Many investors are still nervous from the wake of the volatility in energy-related bonds experienced earlier this year.
Kathleen Gaffney, Eaton Vance’s veteran bond investor and portfolio manager, suggests that investor reliance and fixation on yields (without considering the downside risks) generally ends in poor outcomes, especially from an asset allocation and preservation of capital perspective. Investors should weigh the risk / reward outcomes with prudence when constructing an investment portfolio that serves both their short term and long term goals.