Sell-Off Pushes Junk Bond ETFs To Discounts

Includes: HYG, HYS, JNK, PHB
by: Tom Lydon

After funneling billions into high-yield corporate debt exchange traded funds, investors are now dumping the asset class and treating it like any other risky investment. Nevertheless, high-yield, "junk" bond ETFs have attracted a huge following among institutions as a highly liquid alternative to even the underlying securities that the funds seek to track.

According to ETF Industry Association data, over May, the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA:JNK) lost about $1.2 billion in assets under management and the iShares iBoxx High Yield Fund (NYSEARCA:HYG) diminished by $522 million.

In the week ended May 22, junk bond funds saw net outflows of $2.5 billion, one of the largest weekly outflows in 20 years.

Due to the heavy sell-off, HYG was trading at a discount of as low as 0.93% to its indicative net asset value and JNK finished at 0.86% below its NAV on June 1, writes Tom Lauricella MarketBeat. HYG is now trading at a discount of about 0.20% and JNK is back to about a 0.02% discount Tuesday.

A discount occurs when the ETF's market price is below its net asset value as a result of more sellers than net buyers in the market. Typically, the ETF arbitrage mechanism allows market makers to quickly arbitrage the difference between the NAV and price to keep the premium/discounts close to zero percent.

Still, the sell-off has pushed yields on junk bonds to attractive levels. bonds on the BofA Merrill Lynch High Yield Master II Index yielded 7.16% more than the equivalent Treasury at Friday's close, the highest premium, or "spread," so far this year, writes Ben Levisohn for the WSJ Blog.

Meanwhile, institutional investors have been upping their exposure into high-yield bond ETFs. For instance, institutional holders own 51% of HYG, up 11% this year, and 60% of JNK, up 18%, reports Lisa Abramowicz for Bloomberg.

"Liquidity is the main reason that we're using high-yield ETFs right now rather than high-yield bonds," Tim Anderson, chief fixed-income officer at RiverFront Investment Group LLC, said in the Bloomberg article. "In the good old days you could call up one of the major firms and there'd be a halfway decent shot you could sell $15 million, $30 million of bonds to them on the line. They're not keeping the same inventories anymore."

"ETFs have increasingly become a more viable way to express credit views," Eric Gross, a credit strategist at Barclays Plc, said in the article. "We've seen corporate bond liquidity go down across both investment grade and high yield."

Some other high-yield, junk bonds include the PowerShares High Yield Corporate (NYSE:PHB) and PIMCO 0-5 Year High Yield Corporate Bond (NYSEARCA:HYS).

SPDR Barclays Capital High Yield Bond ETF

(Click to enlarge)

Max Chen contributed to this article.

Disclosure: I am long HYG. Tom Lydon's clients own HYG.