Investors dumped speculative grade debt-related exchange traded funds and turned to senior loan and floating rate notes as interest rates inched higher in the last few months. However, the sell-off may be overdone and now junk bonds show attractive valuations, according to BlackRock.
"Our argument, despite the 'floating rate' in the name of the loan asset class, however, was never predicated on the outlook for rising interest rates where it matters for loans: at the 3-month maturity," Jeffrey Rosenberg, BlackRock's chief fixed-income investment strategist, said in a report. "Loans provide protection from rising interest rates not of the recent sort (where longer maturity yields rise) but rather only once a tightening cycle gets underway. That still appears over a year and a half away."
Rosenberg points out that loans outperformed bonds in the previous two months because investors held onto the loans, even as credit risk and duration risk in bonds fueled price declines and pushed investors away while loans continued to attract investors.
"But that disconnect now reverses our original rationale for favoring loans over bonds: relative value. High yield bond yields now stand 200 basis points (2%) higher than just two months ago while loan yields are virtually unchanged. Loans can provide protection from rising interest rates but that is not what you are getting in the short run. Today you get a lot of credit risk for less reward than can be found in bonds."
Nevertheless, BlackRock warned investors about overreaching for yield as the Federal Reserve considers winding down its monthly bond purchasing program.
PowerShares Senior Loan Portfolio (NYSEARCA:BKLN) has been one of the best selling ETFs so far this year, gathering $3.1 billion in assets year-to-date. BKLN is up 1.4% this year. The ETF h as a 4.36% 30-day SEC yield.
In comparison, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) has lost $1.8 billion in assets this year. HYG is down 0.7% year-to-date and has a 5.69% 30-day SEC yield.
Max Chen contributed to this article.
Full disclosure: Tom Lydon's clients own HYG.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.