Bond ETFs: After Fed Easing, Will Junk Bonds Benefit?
In mid-July of last year, I offered a very attractive ETF solution for widening "credit spreads." Specifically, I suggested that one could own the iShares Lehman 7-10 Year Treasury Bond Fund (IEF) and "short sell" the iShares iBoxx High Yield Corporate Bond Fund (HYG).
This approach proved exceptionally lucrative. IEF has returned 15.5% since 7/13/07. Meanwhile, a simultaneous short-selling hedge of HYG resulted in 0%. In essence, the risk associated with a widening spread between "high-yield corporate" (a.k.a. junk) funds and intermediate term U.S. treasury funds had been neutralized.
(The short-selling hedge could have been profitable as well... were it not for the 7.5% annual yield that HYG generated. Effectively, the high yield income stream compensated for the depreciation in price.)
The "credit spread" between IEF and its comparable high-yield debt equivalent has continued to widen. The difference between IEF's annual yield and HYG's annual yield in July 2007 was roughly 3%. Today, the difference in yield alone is north of 4.5%.
Owners of IEF may expect an annual payout of 3.5% while the iShares iBoxx High Yield Corporate Bond Fund (HYG) is at an 8% distribution yield. And, of course, this tells individuals nothing about the appreciation or depreciation component.
Yet here's the question that may determine what takes place over the next 8-9 months: Will the spread between high-risk debt and low-risk debt tighten once the Fed is done easing? If so, junk bond ETFs figure to be a likely beneficiary.
HYG offers a published distribution yield of 8.3% at the present time, with the income paid out monthly. If investors get a whiff of a late 2008/early 2009 recovery, HYG would likely appreciate in value as well. (Economic recovery tends to go hand-in-hand with greater appetite for risk.)
The SPDR Lehman High Yield Bond Fund (JNK) has an 8%+ distribution yield right now as well. However, the ETF has only been around for a few months.
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This article has 1 comment:
- Rich L
- 4 Comments
Mar 27 04:04 PMGreat trade. I have this one on my radar to play for a possible contraction when the time is right. Are there any comparable indexes I can look at to get a better idea of the historical spreads? HYG doesn't go back that far. Thanks