The unwinding of the Federal Reserve’s bond buying program and expectations for continued strengthening of the U.S. economy means interest rates are likely to rise. In response, many investors are steering clear of long-duration corporate bonds and U.S. Treasuries––whose prices would be negatively impacted by rising rates––in favor of short-term and intermediate-term corporate bonds offering relatively higher yields.
Bonds with long durations (a measure of bond price sensitivity to interest rate changes) had negative returns in 2013, while high-yield bond prices rose more than 7.4 percent, according to the Barclays US Corporate High Yield Index. “High-yield isn’t as rate sensitive as other sectors,” says Dave Mazza, State Street’s research chief for SPDR ETFs.
High-yield, or junk bonds actually rise in value as the rate cycle starts to move up because rising rates often come in tandem with improving economic conditions, which strengthens the operations and finances of high-yield bond issuers and lowers their credit risk.
In response, investors increasingly have been shifting their assets toward ETFs that focus on high-yield bonds. State Street, which already offers a pair of domestic high-yield bond funds—the SPDR Barclays High Yield Bond ETF (JNK) and the SPDR Barclays Capital Short Term High Yield Bond ETF (SJNK)—has added a third option with the recently launched SPDR Barclays International High-Yield Bond ETF (IJNK).
These funds offer a combination of decent yields and minimized duration risk. The JNK fund has a dividend yield of 5.90 percent and the SJNK fund’s dividend yield is 5.26 percent. The newly launched international ETF obviously hasn’t paid a dividend yet, but one way to get a rough sense of its potential yield is comparing it to existing international high-yield ETFs such as the iShares Emerging Markets High Yield Bond (EMHY), Market Vectors International High Yield Bond ETF (IHY) and Market Vectors Emerging Markets High Yield Bond ETF (HYEM), all of which have yields at or slightly above 6 percent.
One of the differences between U.S. and international junk bonds is that they have dissimilar default rates, says Mazza, adding that from 1996 through 2012, U.S. junk bonds had a default rate of around 4.4 percent versus default rates of 3.0 percent and 3.4 percent for European and emerging market junk bonds, respectively. And foreign junk bonds often carry slightly higher yields simply because they are perceived as being riskier. “That premium is not warranted,” Mazza notes.
Mazza believes the real benefit from international junk bond exposure is portfolio diversification. “International junk bond prices tend to have a low correlation with domestic junk bonds,” he says.
That view is echoed by Douglas Peebles, chief investment officer and head of fixed income at AllianceBernstein, who in a recent blog wrote the uneven nature of the global economic recovery means that central banks don’t all do the same thing at the same time, and that investing globally can help diffuse U.S. interest-rate risk and increase diversification.
All three State Street high-yield ETFs carry gross expense ratios 0.40 percent, but offer different duration profiles. The SPDR Barclays Capital Short Term High Yield Bond ETF portfolio has a duration of 2.1 years, while the SPDR Barclays High Yield Bond ETF has a duration of 4.1 years and the duration of the SPDR Barclays International High-Yield Bond ETF is 3.6 years. The shorter duration of the SJNK fund made it a popular choice last year when it attracted $2.4 billion in net new inflows while the JNK had a similar level of outflows.
Regarding the IJNK fund, roughly 80 percent of its high-yield bond portfolio is from issuers in developed markets led by Italy (13 percent), the U.K. (11 percent) and France (9 percent). The other 20 percent come from emerging markets. In all, 46 countries are represented in this ETF.