Indexology^® Blog

As the Puerto Rico municipal bond saga continues it may be helpful to look at how other distressed municipal bonds have performed through Friday December 4th 2015.

The S&P Municipal Bond Default Index tracks municipal bonds that have entered default by not paying all or part of the promised principal or interest when due.  It currently tracks over 250 bonds with a par value of over $5.4 billion.   Within the index there are several sectors which have historically had the majority of defaults take place.  Those sectors are the  land backed, health care, corporate Backed and multifamily sectors.

Table 1: Municipal bond indices tracking defaulted bonds:

So far, the S&P Municipal Bond Default Index is in negative territory with a return of -1.54%.  Corporate backed municipal bonds have seen a positive return of over 5.4%.  Smaller sectors such as the health care and multifamily sectors have seen significant negative results with health care bonds being crushed by over 35% in 2015.

If and as the Puerto Rico bonds default it can be expected that they will be added to the S&P Municipal Bond Default Index during a monthly index rebalancing and if they do they may have a significant weight in this index.

The junk or high yield bond markets in the U.S. have seen diverse returns so far in 2015.  Municipal junk bonds are out performing both the senior loan and fixed rate corporate high yield segments of the market.  While municipal bonds are being buffeted by Puerto Rico corporate bonds and loans are seeing more significant head winds.

Table 1:  Select indices tracking below investment grade segments of the debt markets.

When looking a little deeper into  ratings categories within these segments the municipal bond market has continued to shine.  Starting with the investment grade BBB ratings category, municipal bonds have had a return of nearly 3.5% year-to-date while the large entities tracked in the S&P 500 BBB Investment Grade Corporate Bond Index has recorded a negative 0.46%.  Moving into the below investment grade category of BB+ and below municipal bonds are still outpacing their corporate counterparts.  The BB quality range is being impacted by energy bond issues, such as those from Chesapeake Energy, which are playing a big role in dragging down the corporate bond junk sector in 2015.

Table 2: Select indices representing specific ratings categories of the debt markets.

The impact of low energy prices is rippling through the debt markets for bonds issued by energy related companies.  The S&P 500 Bond Index has returned a modestly negative total return of -0.31% year-to-date while the energy bond sector tracked in the S&P 500 Energy Corporate Bond Index is down 5.79% year-to-date.

Table 1: Select Sector Indices from the S&P 500 Bond Index family:

The credit default market also has reacted.  The cost of buying default protection on the debt of the 10 entities in the S&P/ISDA CDS U.S. Energy Select 10 Index has shot upward by over 150% since May 1st 2015 from 213bps to end December 3rd 2015 at 539bps.  This could be an indication that market participants are expecting more downward pressure for this sector over the near term.

Chart 1: Select S&P/ISDA U.S. CDS Indices

Table 2: The 10 entities in the S&P/ISDA U.S. Energy Select 10 Index as of December 3rd 2015:

Consistency and balance are often essential qualities for a strong portfolio. In the fixed income space, investors can look to the S&P International Corporate Bond Index to bolster the stability and diversity of their investments through exposure to investment grade corporate debt outside the United States.

International corporate bonds are issued in a variety of non-U.S. dollar currencies, which helps mitigate U.S. dollar risk. In an environment where the U.S. dollar is weakening, having a basket of non-U.S. dollar securities tends to add to total return after currency translation. Beyond that, international bonds have demonstrated a relatively low correlation with the domestic and global equity marketplace, as well as with fixed income. Diversifying with international corporate bonds can potentially reduce exposure to market variations of a single currency, issuer, and asset class.

When comparing the S&P International Corporate Bond Index to indices of different asset classes and even similar indices within the same asset class we can find additional reasons to take interest in international bonds. Historically, the S&P International Corporate Bond Index has demonstrated relatively lower volatility than equity and commodity indices such as the   S&P 500® and the S&P GSCI®.  In addition, as of November 30^th, the average rating quality of the S&P International Bond Index outranks that of the S&P U.S. Issued Investment Grade Corporate Bond Index with average weighted ratings of A/A- and A-/BBB+, respectively.  While high quality ratings often imply lower yields, the S&P International Corporate Bond Index has a weighted average yield-to-worst of 2.16%, which is higher than the average yields of U.S. treasuries and comparable to the 2.26% yield of the S&P 500 AAA Investment Corporate Bond Index. In all, international corporate bonds can be a dependable and important part of an investor’s portfolio.

While the Puerto Rico municipal bond market saga continues the damage it has done has been significant.    Puerto Rico municipal bonds represent approximately 23% of the market value of the S&P Municipal Bond High Yield Index.  The impact on total returns of this segment of the market have been dramatic.  The table below illustrates the performance with and without Puerto Rico.  High yield municipal bonds have actually had an excellent year in total return of over 6%, that is when you exclude Puerto Rico exposure.  Happy to send the time series of data on both indices to those interested in diving deeper.

Table 1: Select Municipal Bond Index Returns

The chart below shows performance over time of the two indices both reset to 100 as of November 2011.

Chart 1: Select Municipal Bond Indices Total Return Index Levels