Patient Investors Could Be Rewarded for Junk Bond Faith

he widely followed Markit iBoxx USD Liquid High Yield Index is down 9.56% year-to-date, as of July 28. In a vacuum, that’s enough for many investors to gloss over high yield bonds.

On the other hand, with the asset scuffling, this could be the ideal time for income investors to potentially buy low and sell high with junk bonds. After all, the lower a bond’s starting price is, the better an investor’s chances are for upside potential. The Franklin Liberty High Yield Corporate ETF (FLHY) is an example of an exchange traded fund that could help investors position for a high yield bond resurgence.

For multiple reasons, FLHY merits consideration today. First, the aforementioned Markit iBoxx USD Liquid High Yield isn’t performing dramatically more poorly than the Bloomberg US Aggregate Bond Index, indicating that risk-tolerant investors may want to evaluate the income opportunities available with FLHY rather than a basic aggregate bond strategy.

Second, FLHY is actively managed. That’s beneficial because high yield corporate debt can be an asset class conducive to active management. Additionally, by not being constrained by an index, FLHY’s managers can avoid potential default while identifying value opportunities. It’s also possible that with human input, an active high yield strategy can better identify rising stars — those junk bonds best positioned to be promoted to investment-grade status.

Another reason, albeit longer-ranging, to mull FLHY is that some high-level investors are expressing faith in the possibilities of a high yield rebound by forming new distressed debt funds.

“Several U.S. distressed debt asset managers are in fundraising talks with investors to boost their firepower, anticipating that a recession will create more opportunities to snap up and profit off troubled companies’ debt, according to multiple sources,” reported Reuters. “Investment firms including Oaktree Capital Management, GoldenTree Asset Management, Monarch Alternative Capital and Avenue Capital Group, in recent weeks began marketing their plans to institutional investors such as pension funds and endowments, according to eight investors familiar with the matter.”

Investors shouldn’t conflate distressed debt funds with an asset such as FLHY. The former have more flexibility in terms of the asset classes that can be embraced. Still, activity in the distressed debt arena could be a sign that experts expect that default rates will remain tolerable, which is to the benefit of ETFs such as FLHY.

“Default rates on U.S. junk bonds are at historic lows of around 1%, but in the event of a recession next year, that percentage could climb to 5% by the end of 2023 and peak at 10.3% in 2024,” Reuters reported, citing Deutsche Bank.

For more news, information, and strategy, visit the Volatility Resource Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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