Sector junk bond ETFs from BondBloxx
ETF newcomer Bondbloxx has launched seven sector-specific US junk bond ETFs.
Founded by former BlackRock, Tradeweb and Northern Trust directors, BondBloxx was specialise in niche bond ETFs.
The funds will track sub-indexes of the ICE BofA US Cash Pay High Yield Constrained Index. The indexes are made of junk bonds that meet minimum issuance and liquidity requirements, meaning companies must be heavily indebted enough for their bonds to get included.
Bonds are put into sectors based on where their issuing companies derive most of their revenue from. Bonds chosen are market weighted, meaning companies that are more heavily indebted will get more weight in the fund.
The index then puts caps on the biggest bond issuers, ensuring no company’s bonds take more than 25% of the index.
The funds charge 0.35%.
Bernie’s commentary – outflows, discounts
The median US junk bond trades once every six weeks, according to data from TRACE. They rarely trade due to government restrictions introduced after the 2008 financial crisis. Governments didn’t want banks creating nasty debts and dumping them on others. So they introduced the Volcker rule and capital requirements to force banks to eat the debts (bonds) that they create when they lend money.
Into this void junk bond ETFs have stepped. As bond ETFs trade on exchange and have their own market making system independent of the banks, they’ve provided a way to trade bonds without the banks.
While this has the great strength of opening up the bond market, junk bond ETFs can become unstuck when volatility rises. During crises, such as covid March 2020, junk bond ETFs trade at discounts. This is because the ETFs cannot sell the junk bonds they hold, as no-one trades the bonds. This matters for these launches as one suspects they will inevitably hit discounts when volatility skyrockets.
The other question I’d have for these launches is what happens if rates keep rising. Junk bond ETFs have seen big outflows this year as investors flee debt-ridden companies. This year, the three biggest junk bond ETFs (USHY, JNK, HYG) have collectively lost $6.4 billion to outflows—that’s a lot of money to lose in seven weeks. As such, one suspects junk bond ETFs in this market will be a hard sell.