TEXT-S&P: high-yield ETFs, a growing slice of speculative-grade market

Wed Nov 7, 2012 11:18am EST

Nov 7 - As investors continue their quest for yield amidst low interest
rates, high-yield exchange-traded funds (ETFs) have been playing an increasingly
important role in the market for speculative-grade bonds (those rated 'BB+' and
lower), said an article published today by Standard & Poor's Global Fixed Income
Research, titled "High-Yield ETFs Represent A Narrow But Growing Slice Of The
U.S. Speculative-Grade Market." 

"The demand for fixed-income ETFs has been brisk in recent years," said Diane 
Vazza, head of Standard & Poor's Global Fixed Income Research. "High-yield 
ETFs attracted $1.6 billion of net new money in September 2012, according to 
data from Lipper." This net inflow was roughly equivalent to 4.5% of new 
speculative-grade bond issuance during the month. Although there has been a 
net withdrawal of investor funds from high-yield ETFs over the past few weeks, 
investments in high-yield ETFs increased by a net $9.1 billion this year 
through mid-October. 

"However, the ease with which investors can enter and exit ETF investments 
creates new and risky dynamics in the speculative-grade market with the 
potential flow of 'hot money,'" said Ms. Vazza. Speculative-grade companies 
have a higher default risk than investment-grade companies. Therefore, when 
the credit cycle turns against investors, losses from defaults can quickly 
outstrip the additional interest payments that high-yield investors receive. 
Since we are entering the stage of declining credit quality in the current 
credit cycle, the credit quality of an issuer or a portfolio has become 
paramount. 

Managers of high-yield ETFs aim to get returns that correspond to various 
high-yield indices, and, as a result, they invest in a narrower slice of the 
speculative-grade market than we analyze in our Global Fixed Income Research 
publications. Standard & Poor's Ratings Services rates 1,548 speculative-grade 
companies in the U.S., while the two largest high-yield ETFs hold bonds from 
fewer than 300 issuers each. Since high-yield ETFs are growing in importance 
to the speculative-grade market, we believe it is important that investors 
understand the differences between the funds' holdings and the total market of 
speculative-grade companies that Standard & Poor's rates. 

The report is available to subscribers of RatingsDirect on the Global Credit 
Portal at www.globalcreditportal.com. If you are not a RatingsDirect 
subscriber, you may purchase a copy of the report by calling (1) 212-438-7280 
or sending an e-mail to research_request@standardandpoors.com. Ratings 
information can also be found on Standard & Poor's public Web site by using 
the Ratings search box located in the left column at www.standardandpoors.com.
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