Why are junk bond yields the lowest ever on record?

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Nov. 20 2020, Updated 2:27 p.m. ET

Yields for high-yield debt reach a historic low

Yields on high-yield (HYG) debt and the spreads between high-yield (JNK) and investment-grade debt kept declining in the week ending June 20. High-yield debt yields (as measured by the BofA Merrill Lynch U.S. High Yield Master II Effective Yield) fell by ten basis points over the week to 5.18% on June 20, 2014—their lowest level ever. The Option Adjusted Spread (or OAS) (as measured by the BofA Merrill Lynch U.S. High Yield Master II Option-Adjusted Spread), declined by 11 basis points to come in at 336 basis points—the lowest since July, 2007. The BofA Merrill Lynch U.S. High Yield Master II Index increased by 0.34% over the week ending June 20, and is up by 5.64% so far this year (up to June 20).

The Fed’s June Federal Open Market Committee (or FOMC) meeting, which reiterated the prospect of low yields in debt markets for some time to come, probably resulted in the decrease in yields.

Secondary market activity

High-yield mutual funds reversed six weeks of inflows last week, recording outflows totaling c. $239 million in the week ending June 20. Net flows into high-yield mutual funds are up by c. $5.86 billion so far in 2014 (Source: Lipper).

Return comparisons

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Returns on high-yield debt correlate more to stock market returns (IVV) rather than the returns on other forms of debt, as spreads between investment-grade and non-investment grade bonds usually decline due the belief that high-yield debt would have improved debt servicing ability in an economic expansion.

With the S&P 500 Index (VOO) breaching record after record this year, returns on high-yield debt have also climbed. ETFs like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), the SPDR Barclays Capital High Yield Bond ETF (JNK), and the SPDR Barclays Capital Short Term High Yield Bond ETF (SJNK) have provided market returns of 4.31%, 4.39%, and 2.47% year-to-date (or YTD) (Source: Yahoo Finance, through May 31), respectively, compared to 4.85% for the Vanguard S&P 500 Index ETF (VOO). The three high-yield debt ETFs hold debt in entities rated below-investment grade including companies like Sallie Mae (SLN).

What are high-yield (HYG) or junk bonds (JNK)?

High-yield bonds (HYG) or junk bonds (JNK) are rated below investment-grade (for example—BB+ and below) as per the Standard & Poor’s ratings system. Credit ratings  are an assessment made by ratings agencies like Standard & Poor’s and Moody’s that provide an opinion on the borrower’s ability to make timely payments of interest and principal. In general, higher ratings imply lower credit or default risk, while lower ratings imply the opposite. Due the higher risk entailed in high-yield debt, investors also require a higher return to compensate them for the risk.

In the next section, we’ll discuss the major deals in high-yield primary market. Please continue reading the next section in this series.

 

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