2023-09-20 02:31:31 ET
Summary
- SPDR Bloomberg Short Term High Yield Bond ETF holds short-term corporate debt that is below investment grade.
- SJNK has an annualized distribution yield of 8.4%, offering a higher yield compared to risk-free government bonds and money markets but also comes with higher risk.
- Many investors might be turned off by the risk while those with higher risk appetite might appreciate the higher yield and see it worth the risk.
SPDR Bloomberg Short Term High Yield Bond ETF ( SJNK ) is an interesting fund that holds a basket of short-term corporate debt that's about one notch below investment grade (commonly known as "junk bonds"). The fund's high yield is interesting and somewhat enticing but I believe this fund is more suitable for those investors whose risk appetite are on the higher end. For the majority of investors, this is probably a "hold" rather than "buy" due to its riskier nature.
The fund invests into corporate bonds that are rated between Caa3 and Ba1 by Moody's and between CCC- and BB+ by S&P or Fitch. Basically the risk category of bonds held by this fund range from "Substantial Risk" to "Non-Investment Grade Speculative". What makes this fund interesting is that it holds short term bonds that mature in less than 5 years (the average maturity is actually closer to 3 years) so the risk is somewhat lower because short term bonds are easier to roll and less likely to default as compared to longer term bonds.
Credit Rating Scales by Agency (Wolf Street)
What makes this fund unique is probably it's exceptional high distribution yield that is somewhat rare in short-term bond funds that aren't leveraged. The fund currently has an annualized distribution yield of 8.4% based on the latest monthly distribution without any leverage. Normally the fund's average bond holding has a coupon of 6-7% but the current yield is a bit higher since bond prices have been down in the last couple years. If a bond that has a coupon yield of 6% drops 20% in value, its yield will rise to 7.2% for new buyers so this is what we are seeing in bond markets today. Apart from its high yield, the fund is not all that much different from most short term corporate bond funds.
This raises a question for many investors. If this fund yields 8.4% while risk-free government bonds, money markets and bond funds yield about 5.5%, is the extra 3% worth the extra risk? This is a question whose answer will depend on the person because every person has a different investment goal (including different income goals), different risk profile and risk appetite. Some investors might feel that the extra 3% is worth the risk considering the economy appears to be fairly strong and resilient and we haven't seen any major bankruptcies recently with the exception of a few regional banks which had bad risk management. Then one might also think that we are overdue for a major credit event since we haven't had one in a long time and the Fed has been hiking rates for a while so something might be about to break. When "something" in the economy breaks, the first companies to suffer are the ones whose bonds have a junk rating.
The fund appears to be somewhat well-diversified with close to 900 holdings so even if some of these companies default on their debt, the fund should be ok. It would take quite a lot of default events to put the fund's solvency in risk. Having said that, the fund can still suffer NAV damage while still remaining solvent. The fund's top holdings include some familiar names such as TransDigm ( TDG ), Caesars Entertainment ( CZR ), Carnival Corporation ( CCL ) and American Airlines ( AAL ) so we aren't exactly talking about failing companies or anything. Many times companies with junk credit rating might be still highly profitable, generate healthy levels of cash flow or be generally in good financial shape but it might be recovering from a past event that put them in danger. For example we all know how Caesars, Carnival and American Airlines suffered significantly during the COVID-19 pandemic related shutdowns and it will take them a while for them to see their credit ratings upgraded. This could still be an opportunity for some investors who don't mind taking some risk.
The fund is well-diversified but it's still highly concentrated and overweight in certain sectors. By weight, 25% of the fund's total assets are in Consumer Cyclical industry while another 25% is in Communications and Energy combined. Consumer Cyclical is a sector I would pay close attention to in case we enter a recession because this tends to be one of those sectors that are heavily influenced by the overall state of the economy as the "cyclical" part of this sector's name implies. Cyclical goods and services are typically the first things consumers cut spending on when they think they are in financial trouble and this includes things people can do without such as luxury items, vacations and new cars. I am not saying that consumer cyclical companies are bad or uninventable but it's worth keeping an eye on them when the economy is closer to its late cycle (meaning recession might be coming next). Then again time after time we found out how difficult it is to accurately predict a recession (even the Fed's own officers have been wrong before).
Fund's Sector Breakdown (SPDR)
I briefly talked about credit ratings above but if we have to get into more details, we see that roughly half of the fund's holdings are rated either BA1, BA2, BA3 or B1. These are still mostly seen as "below investment grade" or "junk" but at least we are looking at higher-end of the junk spectrum than on the lower end. I would say that about 10% of the fund's bond holdings are at long-term risk of default but the risk is even smaller in shorter term which most of this fund's bond holdings are.
The Fund's Bond Rating Distribution (SPDR)
On a positive side, a great majority of the fund's holdings will mature in the next few years which makes them less risky because it's easier to roll short-term debt, companies are less likely to default on them and duration risk is lower. Traditionally shorter term bonds used to have lower interest rates while bonds with longer maturities progressively got higher and higher rates but lately it's been all over the place with inverted yield curves. Investors can get a similar (or even better) yields with short term bonds as compared to long term bonds of the same company or government entity. Of course if you are a long term buy-and-hold investor who is buying bonds for long-term income, you might still want to buy longer term bonds because you get to lock in high rate for longer periods of time. If you buy shorter term bonds, you might initially get a better rate but it will only be locked in for a few years and when you come back later as your bond matures, you might not find similar deals anywhere.
The Fund's Bond Maturity Breakdown (SPDR)
The fund's share price is down about 20% since inception but it hasn't missed any distribution payments. When bond yields eventually drop back to previous levels, this fund might recover some of its share price losses so there is possibility of a modest upside potential for this fund. Earlier I talked about a recession risk but a recession could also mean that yields could drop significantly and bond prices could benefit nicely but it's not guaranteed.
Bond markets have many moving parts and it's very difficult to predict their future behavior. When it comes to rating agencies, they tend to be a bit more objective when rating bonds as compared to when they are rating stocks because stakes are higher. Junk bonds are not the best quality bonds but some investors might still find value in them if they feel adventurous and don't mind taking a bit more risk. At the end of the day if you want to chase a higher yield and take your chance with junk bonds, you would rather do it with a well-diversified fund that is holding close to 900 bonds than try to pick individual bonds yourself.
For further details see:
SJNK: 8.4% Yielder - Probably Only Suitable For Investors With Higher Risk Appetite