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Profit from Retailers' Defaults With These ETFs

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The retail sector has seen a slew of bankruptcies this year and the scenario may continue next year too. As per Fitch Ratings, “the sector is expected to again produce the most defaults at up to $7 billion, resulting in a 10% default rate” as quoted on MarketWatch.

With Toys ‘R’ Us filing for bankruptcy, the trailing 12-month retail default rate was 7.3% in September, up from just above 5% in July and August. If we go by the article published on MarketWatch, the retail sector makes up about 30% of the defaults so far this year, “with six issuers defaulting on debt totaling $5 billion.”

The Toys'R'Us bankruptcy also spelt trouble for toy-maker Hasbro (HAS - Free Report) which was down 8.6% on Oct 23. This is because Hasbro generates about 9% of its revenues from Toys'R'Us. It has also triggered uncertainty over when and how many toys would be shipped to the retailer in the fourth quarter or the holiday season.

Why Such Disaster in the Retail Space?

Consumers’ tendency to shift to online shopping or ‘Amazonization’ led many companies to invest in technology despite lackluster sales. According to Fitch, “the overall institutional leveraged loan default rate is expected to end 2018 at 2.5%, equal to about $27 billion of debt.”

Higher debt defaults “made financing extremely costly for the buyout effort.” As per a source, the fourth generation of Nordstrom‘s founding family required around $7 billion to go private. Lenders called for a high interest rate. After four months of discussion with potential buyers, the asking price was settled at about 13%, almost twice the average borrowing cost for a retailer, as per the source.

Moody’s Investors Service rated most several businesses as “stressed.” Although we noticed lesser defaults overall in the third quarter, 38% belonged to the retail sector, compared with 17% in the second quarter and none in the first.

Players in the Likely Default Queue

Several companies are on watch by Fitch ratings this time. These include Neiman Marcus Group Inc., J Crew Group Inc., Talbots Inc., Lands’ End Inc. and Cole Haan, PetSmart Inc., Belk Inc., Ann Taylor parent Ascena Retail Group Inc. , Tailored Brands Inc. (TLRD - Free Report) and J.Jill Group Inc.

Against this scenario, many are skeptical of investing in retail ETFs like SPDR S&P Retail ETF (XRT - Free Report) , VanEck Vectors Retail ETF (RTH - Free Report) and PowerShares Dynamic Retail ETF (PMR).

We thus highlight a few ETFs that could save one from any sudden downslide.

Global X Millennials Thematic ETF (MILN - Free Report)

The millennial generation is now mature enough to set a different trend in shopping. As per an article published on MarketWatch, “retailers are now competing for dollars with smartphones, apps and electronics, as well as experiences such as travel and entertainment.” Mall business has been under pressure. So, it’s better to target millennial-friendly ETFs (read: 3 ETFs to Tap Upbeat Electronics Sales Forecast).

The $10.2-million fund targets the Indxx Millennials Thematic Index. The fund charges 50 bps in fees. Companies related to “social media and entertainment, food and dining, clothing and apparel, health and fitness, travel and mobility, education and employment, housing and home goods, and financial services” get prominence in this fund (read: Inside the Rise of Thematic ETFs).

Amplify Online Retail ETF (IBUY - Free Report)

Given the rapid emergence of online retailing, this online retail ETF deserves a special look. The fund gives investors a way to own a basket of companies with significant revenues from online and virtual retail sales. The fund tracks the EQM Online Retail Index. Overstock Com Inc. occupies the first spot of the fund with about 5.64% exposure (read: Build Your Portfolio With 4 ETFs in Q4).

iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD - Free Report)

Amid rising debt defaults, it’s better to target an investment-grade corporate bond fund. The fund targets the Markit iBoxx USD Liquid Investment Grade Index. The fund yields about 3.16% annually. Banking (27.76%), Consumer Non-Cyclical (17.33%) and Communications (12.34%) are the top three sectors. AAA-rated bonds hold 2.82% of the fund followed by AA Rated (10.76%) and A Rated (39.47%).

First Trust Nasdaq Retail ETF (FTXD - Free Report)

The fund follows the Nasdaq US Smart Retail Index and holds 48 stocks in its basket. Wal-Mart Stores, The Home Depot, e-Bay and hold the top four spots in the fund. Expense ratio comes in at 0.60% (read: E-Commerce Face-Off: Wal-Mart Vs. Amazon ETFs).

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