The Federal Reserve’s first $1.3 billion of purchases of exchange-traded funds that invest in corporate bonds show that funds that focus on buying non-investment grade debt accounted for around one sixth of the central bank’s ETF purchases.
The Fed announced plans to backstop debts of investment-grade firms after the coronavirus pandemic led to a deep freeze across credit markets in mid-March, and it subsequently said in April it would backstop debt for so-called fallen angels, or firms that had been rated investment grade as of March 22 but were subsequently downgraded to junk status.
As part of the backstops, the Fed on May 12 began purchasing exchange-traded funds that provide broad exposure to U.S. corporate bond markets. The Fed said the “preponderance” of those holdings would be in funds whose primary investment objective was in the market for debts with investment-grade ratings, but officials said they would allow for some purchases of ETFs with exposure to junk bonds.
The decision to invest in junk debt has been controversial. Some investors have argued that the central bank risked a deeper credit freeze that would lead to higher unemployment if the central bank shunned riskier assets, while others warned that doing so would reward firms and their investors that were already vulnerable to an economic downturn before the crisis due to heavy debt burdens.
The disclosures of 158 transactions cover purchases made between May 12 and 18. Of the Fed’s $1.3 billion in ETF holdings as of May 19, around 17% were in funds that invest primarily in junk debt. The funds the Fed invested in have appreciated 2.7% on average since purchases began on May 12, according to Roberto Perli of Cornerstone Macro, a research firm.
The Fed owned $100 million in iShares iBoxx High Yield Corporate Bond ETF, which as of Thursday included small holdings of bonds issued by rental car company Hertz Global Holdings Inc., which filed for bankruptcy protection on May 22. It also included small holdings of retailers J.C. Penney Co. and Neiman Marcus Group Inc. and oil-shale driller Whiting Petroleum Corp., all of which filed for bankruptcy in recent weeks.
Three ETFs accounted for the majority of the Fed’s investments: iShares iBoxx US Dollar Investment Grade Corporate Bond ETF, Vanguard Intermediate-Term Corporate Bond ETF and Vanguard Short-Term Corporate Bond ETF. The Fed can’t purchase more than 20% of an ETF’s assets.
The Fed owned nearly $3 billion in ETFs as of Wednesday, according to a separate disclosure, representing less than 2% of all U.S.-listed corporate bond ETFs, according to BofA Global Research.
The Fed has said it would purchase up to $250 billion in outstanding corporate debt and up to $500 billion in newly issued debt, but the mere announcement of the lending programs helped sharply reduce borrowing costs for an array of businesses, meaning the facilities may see less use than initially anticipated if markets don’t deteriorate again. The Fed’s lending programs aren’t fully operational and have so far only conducted ETF purchases.
Fed Chairman Jerome Powell defended the decision to purchase the debt of fallen angels and other non-investment grade companies Friday during an online discussion hosted by Princeton University.
“By announcing our facility and including those companies—the ones who actually needed the credit in March—those companies have now been able to go out and finance themselves, and have now lots of cash on their balance sheets,” said Mr. Powell. “They’ve been able to avoid layoffs. That is the point of all this.”
Mr. Powell said disclosing the Fed’s purchases would be an important way to demonstrate how it was meeting those goals and to avoid misinformation over where the central bank’s loans go.
“Disclosure will really help because I read things in the paper that are supposedly happening, and I know they’re not happening,” he said. “One reason they’re not happening is we actually haven’t made very many loans yet.”
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