The unwinding of the Federal Reserve’s bond purchase program, and the gradual improvement of the US labor market, will result in a hike in interest rates, possibly by the spring of 2015 as mentioned by Fed chairwoman Janet Yellen after the last FOMC meet.
Anticipating the shift, many investors are steering clear of long-duration US Treasuries and corporate bonds, but are unsure about how to replace the high-grade fixed-income assets that were once the foundation of their portfolios.
To bridge this gap, Boston, Massachusetts-based State Street Global Advisors, the second-largest US issuer of exchange-traded funds, unveiled the SPDR Barclays International High Yield Bond ETF (IJNK). The new fund tracks the Barclays Global ex-US Issuers High Yield Corporate Bond Index, a gauge that measures the performance of ex-US high yield corporate income markets, including securities from emerging markets. The securities in the index must have a minimum $350 million in market capitalization in local currency terms and at least one year remaining to maturity.
Prices of investment-grade long-duration securities were negatively impacted in 2013, resulting in negative returns. But prices of high-yield bonds rose more than 7.4 percent during the same period, according to Barclays US Corporate High Yield Index. High-yield bond prices are less sensitive to rising interest rates.
In fact, as the rate cycle starts to move up, high-yield or “junk” bonds actually gain in value because rising rates are invariably preceded by an improving economic environment. A stronger economy improves the operations and finances of junk-bond issuers, lowering their credit risk.
IJNK excludes convertible bonds, structured products, floating rate notes, warrants and linked bonds. The underlying index comprised of 716 securities from 46 countries outside the US as of Feb 28, 2014. About 80 percent of the portfolio contains securities from developed market issuers, led by Italy (13 percent), the UK (11 percent) and France (9 percent).
One of the benefits of international junk bonds is that they have lower default rates. Data shows US junk bond default rate hovered around 4.4 percent from 1996 through 2012 while default rates of European and emerging market junk bonds were 3.0 percent and 3.4 percent, respectively. Also, international junk bonds show low correlation with US domestic high-yield bonds.
IJNK has an annual expense ratio of 0.4 percent.
Disclosure: No holdings