These are trying times for high-yield funds and the related exchange-traded funds (ETFs) and the Federal Reserve’s four interest rate hikes this year are just part of the reason junk bonds are struggling.
The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG), the largest junk ETF by assets, is sporting a modest year-to-date decline, but high-yield funds and junk ETFs face an array of issues. Some investors are not waiting around to see how things play out with junk ETFs as two such funds, including HYG, are among this year’s 10 worst ETFs in terms of assets lost.
Tumbling oil prices are plaguing junk ETFs because several of the most widely followed high-yield indexes feature significant weights to energy issuers. Additionally, investors are departing CCC-rated junks bonds, the riskiest high-yield debt, after embracing the corner of the junk market earlier this year.
“When high-yield spreads hit a post-crisis tight of 316bp over Treasuries on October 3, CCC rated bonds were leading the pack in the corporate bond space, according to ICE BAML data,” Reuters reports. “But those returns have evaporated after a sharp sell-off driven by concerns over the economic outlook, trade wars, falling oil prices and a volatile stock market.”
For bold income investors, here are some junk ETFs to consider in 2019.
IQ S&P High Yield Low Volatility Bond ETF (HYLV)
Expense Ratio: 0.40% per year, or $40 per $10,000 invested
In volatile times, investors often flock to low volatility strategies. The IQ S&P High Yield Low Volatility Bond ETF (NYSEARCA:HYLV) was one of the first junk ETFs to focus on the low volatility factor. HYLV, which turns two years old in February, tracks the S&P U.S. High Yield Low Volatility Corporate Bond Index.
“The Index is compromised of U.S. dollar denominated high yield corporate bonds that have been selected in accordance with a rules-based methodology that seeks to identify securities that, in the aggregate, are expected to have lower volatility relative to the broad U.S. dollar denominated high yield corporate bond market,” according to IndexIQ.
At the end of the third quarter, HYLV held over 400 bonds with an effective duration of 3.82 years. As a low volatility fund, this junk ETF had a barely noticeable weight to highly speculative CCC-rated bonds. Approximately 84% of HYLV’s holdings have one of the three BB ratings. Although HYLV aims to skimp on volatility, its 30-day SEC yield of 4.73% is still solid.
Xtrackers Low Beta High Yield Bond ETF (HYDW)
Expense Ratio: 0.25%
Keeping with the theme of junk ETFs that look to reduce volatility, there is the Xtrackers Low Beta High Yield Bond ETF (NYSEARCA:HYDW), which debuted earlier this year. This junk ETF has over $137 million in assets under management, making it one of the more successful bond ETFs to come to market in 2018.
HYDW follows the Solactive USD High Yield Corporates Total Market Low Beta Index and holds 442 junk bonds. That index holds junk debt that display favorable, lower beta traits relative to the broader universe of high-yield debt.
While HYDW has an energy allocation of 15.62%, its second-largest sector weight, the junk ETF has scant CCC exposure as almost 97% of its holdings are rated BB or B. HYDW has a modified duration to worst of 2.94.
ProShares High Yield—Interest Rate Hedged (HYHG)
Expense Ratio: 0.50%
On Wednesday, Dec. 18, the Federal Reserve boosted interest rates for the fourth time this year. That was not surprising. What was surprising was the Fed’s hawkish tone, indicating more rate increases than previously expected could be in the offing for 2019. Should that scenario come to pass, rate hedged strategies, such as the ProShares High Yield—Interest Rate Hedged (CBOE:HYHG) could be in the spotlight.
This junk ETF has a net effective duration of -0.26 years, indicating rate risk is practically an afterthought. HYHG aims for “zero interest rate risk by including a built-in hedge against rising rates that uses short positions in U.S. Treasury futures,” according to ProShares.
Typically, diminishing rate risk also means diminishing yield, but that is not the case with this junk ETF as HYHG has a 30-day SEC yield of 6.84%. There is some credit risk though as this junk ETF allocated about 15% of its weight to CCC-rated bonds at the end of the third quarter.
iShares iBoxx $ High Yield ex Oil & Gas Corporate Bond ETF (HYXE)
Expense Ratio: 0.50%
Oil prices are plunging and they could fall further in 2019 if inventories build and global economic growth contracts. The iShares iBoxx $ High Yield ex Oil & Gas Corporate Bond ETF (NASDAQ:HYXE) can keep investors engaged with junk debt even as crude prices tumble.
HYXE, an oft-overlooked junk ETF, follows the Markit iBoxx USD Liquid High Yield ex-Oil & Gas Index. As evidenced by the fund’s nearly 300 holdings, there is a fairly expansive universe of high-yield bonds when excluding energy issuers. More importantly, as evidenced by HYXE’s 2018 showing, there is something to ditching oil and keeping junk. This junk ETF is actually sporting a modest year-to-date gain.
Ditching energy junk bonds does not diminish this junk ETF’s income potential. HYXE has a 30-day SEC yield of 6.51% and a duration of 3.74 years.
VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL)
Expense Ratio: 0.35%
The VanEck Vectors Fallen Angel High Yield Bond ETF (NYSEARCA:ANGL) is the first ETF to focus on one of the more compelling segments of the bond market, that being fallen angels. Simply put, fallen angels are corporate bonds that are born with investment-grade ratings and that are later downgraded to junk status.
That sounds bad, but historical data shows fallen angels frequently outperform bonds that start out as junk. Since coming to market over six and a half years ago, ANGL has frequently outperformed traditional junk ETFs.
ANGL’s struggles this year are primarily attributable to falling oil prices. During the previous oil bear market, a slew of energy debt was downgraded to junk, with some of those issues making their way to ANGL. This junk ETF has an energy weight of 23.2%, or nearly 500 basis points more than its second-largest sector exposure.
Still, just 7.48% of ANGL’s holdings are rated CCC and the junk ETF compensates investors for risk with a 30-day SEC yield of 6.67%.
As of this writing, Todd Shriber did not hold a position in any of the aforementioned securities.