The $28.4 billion Blackrock Inc.-led industry of exchange-traded funds that buy U.S. junk bonds is expanding into global speculative-grade debt as the notes outperform dollar-denominated securities by the most since 2009.
BlackRock, the world's biggest money manager, opened the first ETFs on April 3 that will invest in junk bonds from Europe to Asia after its iShares iBoxx High Yield Corporate Bond Fund in the U.S. grew to more than $14 billion in less than five years. Van Eck Global, the investment firm founded in 1955, opened its International High Yield Bond ETF the same day.
Fund managers are broadening their investments beyond U.S. debt with yields on junk bonds outside the country almost double the average of the past 10 years. Investors poured a record $31.1 billion into speculative-grade debt in the 14 weeks ended April 2, according to EPFR Global data, and a three-month rally in dollar-denominated junk securities is now losing steam.
“There are many fixed-income managers today who are really reaching out to international and global issuers,” Darek Wojnar, head of product development and management for BlackRock's iShares, said in a telephone interview. “That's one of the ways to diversify sources of yield.”
High-yield bonds sold outside the U.S. returned 10.4 percent in the first quarter, compared with a 5.1 percent gain for junk notes in dollars, according to Bank of America Merrill Lynch index data. That's the biggest three-month outperformance since the period ended July 31, 2009, the data show.
Seek to Replicate
BlackRock's IShares Global ex-USD High Yield Corporate Bond Fund and IShares Emerging Markets High Yield Bond Fund (EMHY) seek to invest in bonds that replicate indexes composed of debt from both developed and emerging countries outside the U.S. The U.S. junk-bond market is about five times the size of the comparable market in Europe, Bank of America Merrill Lynch index data show.
“It is not easy to create a diversified portfolio of European high-yield names,” said Jason Rosiak, head of portfolio management at Pacific Asset Management, the Newport Beach, California affiliate of Pacific Life Insurance Co., in an e-mail. The new ETFs “would create a more liquid vehicle for total return or high-yield investors to gain international exposure.”
Elsewhere in credit markets, a benchmark gauge of U.S. company debt risk jumped by the most in almost four months amid investor concern that Spain may need international aid, deepening Europe's fiscal crisis. Burger chain Wendy's Co. (WEN) set the interest rate it will pay on a $1.125 billion loan to refinance debt. Bon-Ton Stores Inc.'s debentures fell the most in almost three months as the retailer said its March same-store sales dropped, missing analyst estimates.
The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses on corporate debt or to speculate on creditworthiness, climbed 4.4 basis points to a mid-price of 97 basis points as of 5:13 p.m. in New York, according to Markit Group Ltd. That's the biggest daily increase since Dec. 8, when the measure surged 6 basis points.
In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 2.4 to 132.2. The Markit iTraxx Japan index was little changed at 159.5 basis points as of 9:05 a.m. in Tokyo, according to Deutsche Bank AG. The gauge closed yesterday at 158.9, the highest level since March 23, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.
The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Markets in Australia, Hong Kong and Singapore are closed today for a public holiday.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, rose 0.88 basis point to 29.19 basis points, the highest level since Feb. 27. The gauge, which has climbed from an almost eight-month low on March 28, widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
Bonds of Fairfield, Connecticut-based General Electric Co. (GE), the world's largest maker of jet engines, were the most actively traded U.S. corporate securities by dealers yesterday, with 123 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Bon-Ton's $480 million of 10.25 percent notes due March 2014 fell 2.25 cents to 85.75 cents on the dollar to yield 19.4 percent, Trace data show. That's the biggest drop since Jan. 13.
Comparable-store sales for the five weeks ended March 31 fell 0.1 percent to $254.1 million, compared with $254.5 million in the same period last year, York, Pennsylvania-based Bon-Ton said yesterday in a statement. The figure came in below the 1.7 percent average projection from analysts surveyed by researcher Retail Metrics Inc.
The Standard & Poor's/LSTA U.S. Leveraged Loan 100 index fell for the first time in four days to a more than three-week low, declining 0.05 cent to 93.6 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first- lien leveraged loans, has returned 4.3 percent this year.
Leveraged loans and high-yield bonds are rated below Baa3 by Moody's Investors Service and lower than BBB- by S&P.
Wendy's, the second-largest U.S. hamburger chain, is seeking its term loan B to refinance debt, according to a person with knowledge of the transaction. The Dublin, Ohio-based fast food company's debt, due in seven years, will pay 3.5 percentage points to 3.75 percentage points more than the London interbank offered rate, said the person, who declined to be identified because the terms are private.
Libor, a rate banks say they can borrow in dollars from each other that acts as a benchmark for about $360 trillion of financial instruments worldwide, will have a 1.25 percent floor. Wendy's is proposing to sell the loan at 99 cents on the dollar, the person said, reducing proceeds for the company and boosting the yield to investors.
In emerging markets, relative yields rose for a second day, climbing 5 basis points to 346 basis points, or 3.46 percentage points, according to JPMorgan Chase & Co.'s EMBI Global index. The guage has averaged 376 basis points this year.
With the Federal Reserve saying economic conditions will probably warrant interest rates remaining near zero through at least 2014, ETFs are gaining in popularity with individuals seeking higher-yielding investments. European speculative-grade debt is yielding an average of 8.4 percent, versus a 7.3 percent yield on comparable debt in the U.S., Bank of America Merrill Lynch index data show.
“There's a growing universe of high-yield debt globally,” said Francis Rodilosso, an investment manager at Van Eck Associates Corp. “With the advances of the ETFs and more people getting exposure to high-yield debt, it made sense to create an alternative way for people to seek higher-yielding assets.”
ETFs, which drew congressional scrutiny last year as more complex and riskier versions emerged, allow individual investors to speculate on debt ranked below investment grade without owning the bonds. Unlike mutual funds, which have shares that are priced once a day, ETFs are listed on exchanges and bought and sold like stocks.
Market Vectors's International High Yield Bond Fund ETF will track an index of speculative-grade debt sold by companies throughout the world, including emerging markets, according to a prospectus filed on March 29.
High-yield bond ETFs recorded $6.9 billion of U.S. inflows during the first three months, compared with $1.9 billion of inflows in the comparable period in 2011, according to data compiled by London-based ETF Global Insight. Global inflows have totaled $7.9 billion so far this year, the data show.
Yields on U.S. high-yield bonds are within 0.5 percentage point of the record low of 7.19 percent reached in May 2011, Bank of America Merrill Lynch index data show. The debt has lost 0.1 percent since the end of February amid concern that Europe's debt crisis may be escalating.
BlackRock's global junk-bond ETF aims to invest at least 40 percent of its assets in companies located or doing business outside the U.S., according to a prospectus filed on March 29.
The fund which won't try to beat the index it tracks or position itself defensively when markets decline or appear overvalued, will charge a management fee of 0.55 percent and be overseen by James Mauro and Scott Radell, the document said.
While passive management “may eliminate the chance that the fund will substantially outperform the underlying index,” it “may reduce some risks of active management, such as poor security selection,” according to the prospectus.
“The passive approach is what many of our clients seek,” Wojnar said. “We always start by asking, what is the client's problem that we're trying to solve.”
Investors in ETFs are often seeking the ability to sell quickly, making them more volatile compared with traditional buyers of corporate debt, such as pension plans and insurance companies, Rosiak said.
The key to the new funds' success “will be portfolio diversification and construction in a market that has historically has less liquidity than the domestic arena,” he said.