Tag Archives: jnk

Cash-To-Debt Ratio Demonstrates Why Riskier Assets Have Limited Upside Potential

Cash on corporate balance sheets grew at a 1% pace to $1.84 billion in 2015. That’s a record level of dollars on the books. On the other hand, debt grew at a clip of nearly 14.8% to $6.6 trillion from $5.75 trillion. That’s a 15% surge in debt obligations. In fact, American companies have grown their debt load at a double-digit annualized rate since the economic recovery began in 2009. Doing so has put corporations in a precarious situation – circumstances where cash as a percentage of debt is lower than at any time since the Great Recession. Obviously, the data points themselves are unnerving. Yet, the trend for cash as a percentage of total debt over time may be even more alarming. Consider what transpired between 2006 and 2008. Cash growth began to slow. Debt began to skyrocket. And cash as a percentage of debt steadily declined until, eventually, stocks of corporations found themselves losing HALF of their value. Are stocks set to log -50% bearish losses going forward? Perhaps. Perhaps not. Yet the notion that debt can perpetually grow at a double-digit rate without adverse consequences is about as inane as the idea that the U.S. government’s debt troubles are irrelevant to the country’s well-being. At least in the U.S. government’s case, its leadership can print currency and/or manipulate borrowing costs. (Note: That is not an endorsement of policy; rather, it is an acknowledgement of government power.) Companies? They’re at the mercy of the corporate bond market such that, when existing obligations are retired, new debt may need to be issued at much higher yields to entice investors. Think about it. Ratings companies like S&P may find themselves downgrading scores of corporate bonds to junk status due to ungodly cash-to-debt ratios. What’s more, yield-seeking investors might squeamishly back away from speculation if spreads between corporates and treasuries widen further. Additionally, Fed efforts to raise overnight lending rates may push junk yields further out on the ledge where the combination of widening spreads, rating agency downgrades and Fed policy direction collectively reinforce a negative feedback loop. By many accounts, low-rated bonds have been struggling for quite some time. Get a gander at the three-year chart of the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ) below. Granted, the bounce off of the February lows is astonishing. (Channel your gratitude toward a 70%-plus recovery in crude oil prices.) Nevertheless, the total return for JNK is a scant 1.4% over the three-year period. That is negligible reward for a huge amount of risk . In contrast, the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) offered a total return of 9.2% over the same period. That is low risk for reasonable reward. The problem may only get worse. At present, junk status (‘BB’) is the average rating for companies issuing bonds. How bad is that historically? It’s worse than before, during or after the financial collapse in 2008-2009. Indeed, you have to travel back to the 2001 recession to find an average rating as anemic as the one that exists right now. It is certainly true that when the European Central Bank (ECB) announced its quantitative easing (“QE”) intentions in the first quarter, the reality that they’d be acquiring corporate bonds as well as sovereign debt provided a fresh round of speculative yield seeking. Income producing assets that had been struggling under the worry of multiple Fed rate hikes in 2016 – emerging market sovereigns via the PowerShares Emerging Markets Sovereign Debt Portfolio ETF (NYSEARCA: PCY ), the SPDR Barclays International Treasury Bond ETF (NYSEARCA: BWX ), high yield via the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ), crossover corporates via the iShares Baa-Ba Rated Corporate Bond ETF (BATS: QLTB ) as well as the iShares Intermediate Credit Bond ETF (NYSEARCA: CIU ) – rocketed higher. On the flip side, the belief that yield-seeking and risk-seeking behavior will occur as long as central banks keep borrowing costs subdued is flawed. In the bond world, bad ratings eventually override yield-seeking speculation. In the stock world, stretched valuations eventually cap upside potential . It is worth noting, in fact, that the S&P 500 has been flat for 18 long months, which roughly corresponds to when corporate earnings peaked back on 9/30/2014 . Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

ETFs: Passing Marks For Liquidity, But What About Performance?

By Alliance Bernstein Proponents of credit exchange traded funds (ETFs) claim the last week of market turmoil was a test for these instruments-and that they passed. We think this takes grading on a curve to a new level. The cheerleaders say ETFs succeeded because they traded regularly after a high-yield mutual fund failed and barred investor withdrawals. Here’s what they’re not telling you: in exchange for this liquidity, investors ended up with instruments that have woefully underperformed active mutual funds-recently and over many years. For long-term investors who are saving to pay for college or retirement, that’s an awfully steep price to pay for something they don’t really need. The numbers speak for themselves: Over the first 11 months of this year, the two largest ETFs – HYG and JNK – have sharply underperformed the average active manager, not to mention their own benchmarks. They’ve also trailed the average active manager so far in the fourth quarter ( Display ) and since the start of December, one of the year’s most volatile months so far. ETFs’ longer-term performance falls short, too. In fact, not only have active managers outpaced ETFs over the long run, they’ve done it with lower volatility, as measured by risk-adjusted returns. The Sharpe ratio, which measures return per unit of risk, was 0.45 for JNK and 0.51 for HYG between February 2008, shortly after they began trading, and November of this year. For the top 20% of active high-yield managers, it was 0.71. How Much Liquidity Is Enough? Is the ability to get in or out of an ETF at any point in the day worth the underperformance? For asset managers and traders who need to trade frequently to hedge positions, maybe. After all, they’re not investing in these instruments as long-term income generators. But a large share of the people who own high-yield ETFs aren’t traders. They’re regular folks saving for college, or to buy a new home, or for retirement. In other words, they’re investors, not traders. Most probably aren’t doing any intraday trading at all. If they’re buying ETFs for the liquidity, they’re paying-dearly-for something they don’t need. In our view, an actively managed mutual fund is likely to offer higher potential returns over the long run – and give investors a better chance of meeting their goals. In fact, the data suggest that investors who want long-term exposure to high yield would do better to pick an active manager out of a hat than invest in an ETF. With Mutual Funds, Diversification Is Key All well and good, some investors are no doubt thinking. But what happens when mutual funds fail? That’s a fair question. Liquidity is important for everyone, as the failure of Third Avenue Management’s Focused Credit Fund illustrates. But it’s important to remember that this mutual fund was not a typical high-yield fund. It focused almost exclusively on risky distressed debt issued by highly leveraged companies. These types of assets are relatively illiquid, and that became a problem when large number of investors wanted to sell their shares. In other words, investors were promised “daily liquidity”-the ability to buy or sell shares in the mutual fund at the end of each trading day-but the assets the mutual fund owned could not be bought or sold on a daily basis. These types of strategies are bound to fail eventually. Most high-yield managers follow more diversified strategies that focus on a wide array of higher-quality assets. Of course, investors should still make sure their investment managers have a dynamic, multi-sector approach and are managing their liquidity risk effectively . Those who do a good job will be in position to meet redemptions during downturns and seize opportunities as they arise . That’s something Third Avenue couldn’t do. High-yield ETFs can’t do it, either . The recent turbulence in the high-yield market probably isn’t over. But we don’t think that should concern long-term investors too much. In our view, the best approach at this point is probably to ride out the storm. The intraday liquidity ETFs offer comes at a high price-and if you’re a long-term investor in high yield, you shouldn’t be paying it. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Disclosure: None

Why I Will Likely Be A Buyer Of High Yield In 2016

The yield in junk bonds has been steadily rising as the price of the bonds in the underlying portfolio have been falling. The biggest concern in this fixed-income sector has been the decoupling from U.S. equity markets. From a psychological standpoint it seems like we have gone from complacency to extreme fear in a hurry. By now you have probably read everything about the death of high yield bonds, the investor lockup at Third Avenue, and the risk that these “junky” assets pose to exchange-traded funds. Believe me, the financial media is just getting started slicing and dicing this thing up. Everyone loves to sink their teeth into an investment that is tanking. It makes for great headlines and offers a curiously similar effect as gliding by an accident on the freeway. Despite our best intentions, we all slow down to take a peek. As an avid watcher and owner of ETFs , I have been closely monitoring the price action of the iShares iBoxx High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays High Yield Bond ETF (NYSEARCA: JNK ) this year. These two ETFs represent the lions share of the below-investment grade fixed-income space, with combined assets of $25 billion. HYG is now down nearly 10% from its 2015 high and currently sports a 30-day SEC yield of 7.20%. That yield has been steadily rising as the price of the bonds in the underlying portfolio have been falling. The biggest concern in this fixed-income sector has been the decoupling from U.S. equity markets. The SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) is 5% off its high and still in the middle of its 52-week trading range, while high yield bonds continue to make new lows. That is uncharacteristic of the typical correlation between these two asset classes and has many wondering if stocks are going to follow lower or junk bonds will ultimately rebound. You would probably be hard pressed to find anyone admitting to owning these investments at this stage of the game. However, there are literally millions of investors who own some form of junk bonds. That may be through direct exposure in a fund such as HYG or indirectly through diversified corporate funds, aggregate indexes, bank loans, or a multi-asset fund structure. It’s become an ubiquitous part of the chase for yield over the last several years and far more common than most investors understand. From a psychological standpoint it seems like we have gone from complacency to extreme fear in a hurry. HYG peaked in April, yet the accelerated nature of the sharp sell off in the last six weeks has investors whipped up into a frenzy. This is the inner monologue that I imagine has taken place in many heads this year: HYG down 2% – “Bit of a sell-off here. Time to add to my holdings.” HYG down 4% – “Spreads are so juicy at these levels. I’ll nibble on a little more” HYG down 6% – “Well this turned ugly quickly. Maybe I bit off more than I can chew.” HYG down 8% – “Get me the hell out. Cash is king.” HYG down 9% – “Haha, who would be dumb enough to still hold this stuff? Glad I sold down here. Now I’m safe”‘ HYG down 10% – “Wow, look at it still cratering. Maybe I should go short….” That last one made me cringe as I saw several probing articles and social media anecdotes pointing out funds that short junk bonds last week. They certainly do exist, although if you are asking about them at this stage of the game, you are probably a little late to that trade. That’s just my personal opinion – things can always get worse, and we may still face a high volume capitulation event before a true bottom is formed. There are two important points that should be understood at this juncture: This whole thing is probably not as bad as everyone has made it out to be. The “bubble has burst” or “high yield is dead” is likely driven more by headline artists than true investors in this space. We see the same type of sentiment and conviction when stocks go through a 10% corrective event. It’s always the end of the world and yet somehow it’s not. The same psychological cycle of greed and fear that we are accustomed to in stocks is going to take place in this fixed-income sector as well. It will seem cataclysmic and disastrous until it reaches a point where everyone who is going to has sold. That will be the inflection point that will ultimately create a sustainable bottom and drive prices higher. It may be in the form of a V-shaped reversal or a more rounded consolidation that takes months to stabilize and swing higher. No one knows for sure when that inflection point may be. However, I’m closely watching technical indicators such as prior support levels, volume, sentiment, high yield spreads, and other key variables. These will be the pieces to the puzzle that give us some indication that junk bonds have turned the corner. Rather than getting overly bearish at this juncture, I’m viewing the sell off as a long-term tactical opportunity. The key is knowing how this sector fits within the context of your diversified income portfolio and sizing your exposure correctly to your risk tolerance . My plan is to purchase an income-generating asset class at attractive levels relative to other bond alternatives. That’s likely a contrarian view right now, but in 2016 it may look quite different. For now, I’m keeping my powder dry and my eyes open. I suggest that other serious income investors do the same and consider scaling into any new positions slowly over time. This will allow you the flexibility to size your holdings appropriately and use time or price to your advantage.