Where’s the yield? Investors everywhere have been looking for income over the past couple of years as Treasury yields have remained at record lows. This has led to investors searching in every nook and cranny for some sort of yield. And it has caused investors to move out on the risk spectrum in order to quench one’s thirst for yield.
Some investors have even decided to exit the bond markets entirely in efforts to get their needed yield within the equity markets. It seems to be a daily ritual to read headlines that are calling for the death of bond investing and the basis isn’t unwarranted. But, going back to Finance 101, when is it prudent to put all your eggs in one basket (or asset class)?
Income investments serve a purpose for investors who are in need of diversification or looking to generate cash flow to supplement other retirement income streams. Getting caught up in the recent success of the equity markets and searching for yields within stocks only puts investors who need an income allocation at potential risk to achieving their longer term goals.
The days of investing in a 30-year Treasury bond and holding it till maturity are likely over for the time being. Investing in fixed income will thus be more difficult, given that the tailwind we had from rates falling turning into a headwind as rates rise. Thus, it will be more important than in recent memory to expose our fixed income allocations to the right areas.
One of these areas of interest has been the high yield market. But as yield spreads continue to tighten, those bond headlines, which are causing worry among investors, are starting to include the words “high yield” in them. Well, looking at the current option adjusted spread (OAS) on the Barclays US High Yield index, we see that it is currently at 382 basis points—well below the 10-year average of 562 basis points. But the opportunity lies in where the spread has the ability to go. Based on the past 10 years, we saw the lowest OAS for this index back in May 2007 when it hit 233 basis points. Upside is waning, but there still is opportunity in this space, which is reason to cheer in a fixed income market that has limited options.
Now that we have found an opportunity in the high yield space, we can move onto another order of business on the checklist:
• Space is relatively opportunistic • Short duration
Some may not think that the high yield space provides shorter duration options, but one particular ETF has burst onto the scene over the past 18 months to provide this option. The SPDR Barclays Short-Term High Yield Bond ETF (SJNK) provides investors this opportunity. Given the run-up in the high yield space and a lot of investors utilizing the SPDR Barclays High Yield Bond ETF (JNK) during this positive uptrend, now is a good opportunity to take some profits in JNK and shorten the duration (without giving up much yield) by moving to SJNK. The option adjusted duration on SJNK is more than half of that on JNK, while the effective maturity of the underlying bonds for SJNK is just over two years.
It seems that investors are opting to give up a little yield on their high yield exposure in order to shorten duration. Based on the Bloomberg fund flow data for 2013, the average daily fund flow for JNK was -9.82 million, while the average daily fund flow for SJNK for the year was 9.55 million.
What are investors gaining for making the switch? It seems that they are getting a smoother ride during those rate spike periods. Looking back to when Fed Chairman Ben Bernanke introduced the idea of tapering through the end of 2013, the 10-year Treasury yield moved higher by nearly 100 basis points (from 2.04% to 3.03%). During this period, JNK saw its price drop 2.24% (total return of +1.76%). SJNK though saw its price drop only 77 basis points (total return of +2.75%).
SJNK solves many of the possible questions on someone’s “Investing in Fixed Income Today” checklist:
• Space is relatively opportunistic • Short duration • Reasonable yield • Diversifier within a global allocation
So as we enter a period when rates will likely rise over the longer term, SJNK seems poised to be an opportunity to answer investors’ questions on where to get yield, while also being prudent in shortening duration risk in what will inevitably be a rising rate period of time.