These are your best trades when junk bonds rally

Can the Junk Bond Rally continue?
Can the junk bond rally continue?   

As recent market gains have renewed risk appetite, junk bonds are getting a fresh look.

The largest high yield corporate bond ETFs—the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Barclays High Yield Bond ETF (JNK)—both rebounded more than 5 percent in recent weeks. And if history is any guide, the comeback could just be getting started.


Data from Kensho, a tool designed to quantify historical market events, show that after such a gain, the ETFs have continued to climb over the following two weeks.

After JNK rises 5 percent or more in two weeks, it has gone on to add another 3.3 percent on average over the next two weeks. It's also a positive signal for HYG, which gains nearly 2.5 percent on average after such a run.


But if junk bonds are too risky for your appetite, there are some proxy plays that have proved profitable in the past.

The beaten-down financials sector could get a big boost if risk appetite continues to grow. Already, the Select Sector Financial Index has rebounded nearly 5 percent this month as the HYG has climbed.

Financials are the best performing sector when the junk bond ETF is on the rise, followed by consumer discretionary, industrials and materials.

Asset managers should thrive in a risk-on environment. Ordinary investors are typically more willing to pay for active portfolio management and managers should make more on commissions on increased trades.

That's the logic. But some asset managers fare much better than others when high yield corporate debt is back in favor.

Historically, Principal Financial, Calamos Asset Management and Ameriprise Financial have seen the highest average returns over the last decade when HYG is rising 5 percent or more in one month.


Emerging markets also tend to gain when HYG is climbing as investors feel more comfortable searching for yield abroad.

The iShares MSCI BRIC ETF is a small fund, but a reliable bet when junk bonds are gaining. It has traded positive in all 10 instances and returned nearly 14 percent on average. The iShares MSCI Emerging Markets ETF is a much larger and more liquid fund with a stellar record as well, rising in every instance but one. The iShares South Korea and Mexico ETFs are standouts as well.


Serious risks remain that could derail a rebound in risky corporate debt. But the recent rally, strong inflows and historical data may signal that the worst is over.

DISCLOSURE: NBC Universal, the parent company of CNBC, owns a minority stake in Kensho.