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Icahn, Fink Clash Over Junk Bonds

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Are ETFs that invest in high yield debt (junk bonds) like the SPDR Barclays High Yield Bond ETF (JNK) weapons of mass destruction?

Outspoken billionaire investor Carl Icahn thinks so.

Icahn recently sparred with CEO Laurence D. Fink at the CNBC Institutional Investor Delivering Alpha Conference, saying, “This thing is going to go over this cliff and you know what’s going to destroy it? They’re going to hit a black rock.”

Fink, who heads up BlackRock, sponsor of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), took issue with Icahn’s views, labeling them as “dead wrong.”

HYG ($13.95 billion) and JNK ($9.92 billion) are the two largest high-yield bond ETFs by assets.

Bonds with a credit rating of BBB− and lower are typically categorized as high-yield or junk bonds because of their speculative nature. Although yields on junk bonds are usually juicier compared with investment-grade debt, investors absorb larger risks because companies issuing high-yield debt have poor or unestablished credit.

The point of Icahn’s contention is that daily trading volume in high-yield bond ETFs is masking the fact that most bond issues in the underlying index are illiquid and rarely trade. As a result, Icahn claims, ETFs give investors an illusion of liquidity to “extremely illiquid and extremely overpriced” securities.

Combined, HYG and JNK had average daily trading volume of 15,389,700 during the past three months. Although both funds offer intraday liquidity because they can be bought and sold throughout the trading day, the funds currently hold between 800 and 1,000 bond issues that rarely trade.

With 10-year Treasury yields still under 3%, yield-hungry investors have flocked to high-yield bond ETFs in search of more income. HYG and JNK carry 12-month yields ranging from 5.46% to 5.89%.

The junk bond market has soared more than 45% since 2010 to $1.54 trillion. Fueling the surge has been the insatiable hunger by both retail investors and portfolio managers for higher yields. Stellar performance has helped, too. Junk bond ETFs have recorded six consecutive yearly gains since 2009.

Like Icahn, Jeffrey Gundlach, CEO of DoubleLine Capital, sees trouble ahead for the high yield debt market, especially in 2018 and 2019, when many high-yield issues come due. If interest rates rise ahead of those maturity dates, bond issuers who borrowed heavily may experience difficultly rolling over the debt. “That’s the next bond market crisis,” Gundlach said in an April interview with Wall Street Week.

The ProShares Short High Yield ETF (SJB) is designed to increase in value when junk bonds prices fall. SJB delivers -1x or 100% daily opposite performance to the Markit iBoxx Liquid High Yield Index. The fund has around $66 million in assets and averages daily trading volume of almost 35,000 shares.

Icahn dislosed that he uses credit-default swaps to bet against high-yield bonds.

— More by Ron DeLegge on ThinkAdvisor: