Market Extra: There is no relief for junk bond ETFs as oil tanks by nearly 8%

Exchange-traded funds focusing on high-yield corporate paper, or “junk” debt, extended a retreat on Friday, amid a persistent tumble in prices of crude oil.

In the past few weeks, high-yield bonds—those deemed the riskiest debt and that offer commensurately higher coupons, as a result—have suffered amid concerns the investment vehicles are vulnerable to lower crude values. That is because energy bonds make up a sizable, 15%, of benchmark indices focusing on so-called junk debt.

“There is a direct correlation,” James Athey, senior investment manager for Aberdeen Standard Investments, told MarketWatch. “There is a large percentage of the high-yield market that is energy sensitive.”

The view that high-yield and oil are closely linked is shared by many other investors. Mohamed El-Erian, chief economic adviser for Allianz, said in a tweet on Friday that the selloff in high-yield ETFs illustrated how such passive funds contained hefty exposure to the oil market.

See: Junk bonds—no longer 2018’s darling—flip to red as the corporate debt climate deteriorates

The iShares iBoxx $ High Yield Corporate Bond ETF

HYG, -0.55%

slipped around 0.6%, while the SPDR Bloomberg Barclays High Yield Bond ETF

JNK, -0.46%

fell 0.5%. Both funds are down more than 5% this year.

Amid concerns over rising supply and slower global growth, crude prices have entered a bear market, usually defined as a drop of at least 20% from a recent peak. January futures for West Texas intermediate

CLF9, -7.76%

 settled 7.8% lower at $50.39 a barrel, marking the lowest since October 2017, FactSet data show.

The JNK fund, referring to its commonly used ticker, has seen $830 million of outflows this week through Thursday, even as the equally popular, often referred to as HYG on Wall Street, has attracted $377 million of inflows over the same period. On a yearly basis, both reflect investors fleeing from high-yield ETFs, with JNK shedding $4.8 billion and HYG shedding $2.7 billion.

The chart below from Jeroen Blokland, a fund manager for Robeco, shows how high-yield credit spreads have widened in line with sinking oil prices, reflecting investors’ demands for greater compensation to hold on to high-yield debt associated with the oil or energy sector.

After the recent crude slump, the extra compensation paid out to investors holding a basket of high-yield bonds over safer Treasurys, or the credit spread, stood at 4.25 percentage points on Thursday, around its widest levels in nearly two years, from a prerecession low of 3.16 percentage points on Oct 3 (see chart below):



Credit: Jeroen Blokland

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Sunny Oh is a MarketWatch fixed-income reporter based in New York.

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