High bond yields

Sky-high bond yields: Don’t miss out on the opportunity.

At Ziggma, our mission is to empower investors to build wealth the right way, with an emphasis on the word “empower”. As we don’t know our users’ financial situation and constraints, we deliberately refrain from providing any sort of directional advice. Rather, we aim to empower our users to achieve better long-term returns thanks to next-level features such as the portfolio visualizer and by providing one of the best stock research websites on the market.

Pointing out an exceptional opportunity in corporate high yield

Yet, this should not prevent us from pointing out exceptional opportunities. The recent run-up in corporate bond yields marks a case in point. Only twice in the past 10 years have US high yield rates exceeded today’s levels.

Sky-high bond yields

Ice Data Indices, LLC, ICE BofA US High Yield Index Effective Yield [BAMLH0A0HYM2EY], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BAMLH0A0HYM2EY, September 25, 2022.

SJNK: 12.3% yield to maturity

SJNK is a highly diversified high-yield bond ETF issued by State Street Global Advisors. With over $3bn in assets under management, it is highly liquid and managed by one of the most solid issuers in the market. (Full Disclosure: There is no relationship of any sort, commercial or other, between Ziggma and State Street or Ishares. The author of this article holds shares in SJNK).

This past Friday 24th September, SJNK closed with a yield to maturity of 12.3%. This means that absent any defaults the fund’s assets will generate an annual yield of 12.3% if held to maturity. Yield to maturity is driven by two factors. The risk-free rate, which is around 4%, and the run-up in spreads in anticipation of a recession in the US (see the previous chart). The following provides an overview of the fund’s principal (performance) characteristics:

Sky-high bond yields

What happens to the yield in the event of a recession?

Most pundits agree that the US is headed for a recession. But many economic health indicators, barring the housing market, point to a soft landing. The unemployment rate sits at historic lows and consumers still have plenty of savings left from their stimulus checks. Corporate balance sheets, though more leveraged than in the past thanks to ultra-low interest rates, are robust.

US unemployment rate 2012-2022

yield in the event of a recession

Lots of yield cushion in a worst-case scenario

According to rating agency S&P Global, in the US, the average annual default rate on speculative corporate debt over the period 1981 through 2020 was 4.2%. By way of comparison, during the 2009 recession, the default rate jumped to 11.8% before rapidly decreasing to 3.47% in 2010 and 2.16% in 2011. Assuming an absolute worst-case scenario of a 5% annual default rate and an empirical 50% recovery rate based on Moody’s research would generate a drag of 2.5% on the ETF’s yield. Any drag from defaults will be offset by an increase in running yield as new issuances at higher yields are purchased by the ETF over the coming years.

In our view, even in a worst-case scenario, yield to maturity should not drop below 10%. Diversification across 700 different issuers can be expected to shield the ETF from any potential extreme outcome.

When is the perfect entry point?

Naturally, as professional analysts, we do not claim to have a crystal ball to call the time of a price bottom. But we will venture to say that unless things get really ugly, there is a high probability that we are close. Prudent investors will invest sequentially to benefit from cost-averaging in the event that the price of the ETF falls further.

What are the alternatives to SJNK?

The closest alternative to SJNK is Ishares’ SHYG. It also targets short-term high-yield bonds. It is very sizeable at $4.7bn in AUM and benefits from a market-leading counterparty. The following provides a comparison of key performance indicators and fund characteristics.

The most attractive high yield bond ETFs.

Important Notice: This article is not to be construed as investment advice. We do not know your personal financial situation and can thus not advise you. The content in this article is for information only.

Share this

Leave a Comment