New Junk-Bond ETFs Are Born of Fed Moral Hazard: Brian Chappatta

In case there was any uncertainty about the moral hazard created by the Federal Reserve’s decision to buy junk-bond exchange-traded funds, a group of former senior leaders at BlackRock Inc., JPMorgan Asset Management and HSBC is leaving no room for doubt.

BondBloxx Investment Management LLC, which launches on Thursday, plans to run seven separate ETFs that break down the high-yield debt market by sector, Bloomberg News’s Tasos Vossos reported. It intends to use the roughly 2,100 bonds in the ICE BofA U.S. junk bond index to fill funds focused on financial, industrial, telecommunications, health-care, energy, consumer cyclical and consumer noncyclical companies. The members of BondBloxx’s team have collectively launched 350 ETFs in their previous roles.

At first glance, this looks like a gutsy move less than two years removed from the onset of the Covid-19 pandemic and the shocks felt across the fixed-income markets. The iShares iBoxx High Yield Corporate Bond ETF (ticker: HYG) fell 22% in the span of a month through March 23, 2020. The largest ETF covering high-yield municipal bonds (ticker: HYD), an even more illiquid corner of the market, at one point traded at a stunning 28% discount to its net asset value as traders feared impending fire sales from mutual funds in the space. The prospect of BondBloxx running ETFs with a few hundred securities each seems like asking for trouble during the next credit crunch.

Of course, that’s assuming there will ever be another severe credit squeeze. On the same day HYG hit its low, the Fed unveiled its Secondary Market Corporate Credit Facility, granting the central bank power to buy U.S. investment-grade corporate bonds and ETFs tracking that market. Less than three weeks later, it added the ability to buy ETFs “whose primary investment objective is exposure to U.S. high-yield corporate bonds.” That last part in particular defied explanation and created obvious moral-hazard risks.

It shouldn’t be lost on anyone that most of the BondBloxx founders have at some point worked for BlackRock, which the Fed chose to manage assets for the corporate-credit facilities. As of Aug. 31, all of its holdings either matured or were sold, but the market impact remains. The average yield spread on investment-grade debt is 86 basis points, near a record low, while junk bonds offer a pickup of 300 basis points, well below the average of 527 basis points over the past two decades.