Will investors prefer investment grade over high yield in 2014?

Part 2
Will investors prefer investment grade over high yield in 2014? (Part 2 of 7)

High-yield bonds and stocks’ performance over the past 3 years

High yield bonds and stocks

High-yield fixed income ETFs like JNK and HYG have provided total returns in excess of 25% over the past three years. An ETF tracking the S&P 500 Index, the State Street SPDR S&P 500 ETF (SPY), has clocked total returns of 49% over the past three years. The top ten holdings in SPY include iPhone and iPad maker Apple (AAPL), at 4.85% of fund assets, and diversified conglomerate General Electric (GE), with 1.54% of fund assets.

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The SPDR Barclays Capital High Yield Bond ETF (JNK), which tracks the Barclays Capital High Yield Very Liquid Index, has provided total returns of 7.87% over the past year and 25.72% of total return over the past thee years. The Barclays Capital High Yield Very Liquid Index includes publicly issued non–investment grade fixed-rate taxable corporate bonds, with a maturity in excess of one year, with $600 million or more of outstanding face value.

The year-to-date total return (to February 28, 2014) for JNK is 2.89%. The short interest ratio for JNK increased to 7.051x on February 28, 2014—the highest in the ETF’s history, since its inception in November 2007. This implies that, based on average trading volumes, it would take short sellers about seven trading days to buy the number of shares shorted by them.

The iShares iBoxx $ High Yield Corporate Bond ETF (HYG), which tracks the iBoxx $ Liquid High Yield Index, has provided total returns of 7.79% over the past year and 26.23% of total return over the past three years (to February 28, 2014). The iBoxx $ Liquid High Yield Index is rules-based and provides a broad representation of the U.S. dollar–denominated liquid high-yield corporate bond market. The year-to-date (to February 28, 2014) total return for HYG in is 3.23%. The short interest ratio for HYG increased to 7.746x on February 28, 2014—the highest level since September 14, 2007. This implies that, based on average trading volumes, it would take short sellers between seven and eight trading days to buy the number of shares shorted by them.

The short interest, or the number of shares of a security or ETF that have been sold short by short sellers, increased to ~25.9 million on February 28, 2014, for JNK and ~30.2 million on February 14, 2014 for HYG—an all-time high. The short interest ratio for JNK represents over 10% of the total shares outstanding (~248.8 million), while the short interest ratio for HYG represents almost 21% of the total shares outstanding (144 million).

While high-yield bond ETFs like HYG and JNK have performed well in the past three years, why has the short interest ratio for these ETFs suddenly risen to record highs? The short interest ratio measures the number of shares of a security that have been sold short by short sellers, who expect to profit from a fall in the price of the security, which reflects bearish sentiment for these ETFs. To find out why, read on to Part 3 of this series.

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