Why The Next High-Yield Crash 'Will Be Ugly'

In a new report for LCD, Chief Investment Officer of Lehmann Livian Fridson Advisors Marty Fridson discusses the dangers presented by high-yield ETFs. The topic was the subject of a recent contentious debate between BlackRock CEO Laurence Fink and activist investor Carl Icahn at the Delivering Alpha Conference.

Icahns Claim

According to Icahn, high-yield ETFs are dangerous for the market. The instruments have become extremely popular investments, but Icahn contends that the underlying holdings are extremely risky and illiquid. Icahn fails to see who would buy those securities in the event of a large-scale, panicked market sell-off.

ETFs Isolated?

The other side of the argument, represented by Fink, is that ETF buyers trade among themselves and that ETF trading has no effect on the underlying securities. Fink, whose firm sells bond ETFs, believes that the ETFs create extra liquidity in the market, which benefits bond investors.

Fridsons take

In his report, Fridson explains that bear markets can be particularly ugly for high yield ETFs such as SPDR Barclays High Yield Bond ETF (NYSE:JNK), iShares iBoxx $ High Yield Corporate Bd ETF (NYSE:HYG) and PowerShares Senior Loan ETF (NYSE:BKLN). However, Fridson believes that the contention that there is currently a bubble in the high-yield ETF market that has created an unprecedented risk level for investors is inaccurate.

We can be confident that the next high-yield sell-off will feature illiquidity and horrific price gaps, but we have no assurances that the landscape will look uglier than in previous cycles, Fridson explained. Are the investment implications of, say, 15% of all high-yield issues falling by at least 20% in a single month any different from 11% declining by that magnitude, as in June 2002?

Although a harsh downturn in the high-yield market is inevitable at some point in the future, Fridson doesnt see anything particularly unique about the current cycle that would warrant a different investment approach than was advisable during past cycles.