At a time when the 10-year Treasuries yield just 1.75%, the dividend yield on the S&P 500 is only 1.84% and, at one point this year, there were $17 trillion in bonds floating around with negative yields, it’s easy to understand why some investors are turning to high-yield corporate debt.
High-yield bonds, also known as junk bonds, usually come as advertised. For example, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG), the largest junk bond exchange-traded fund (ETF), has a 30-day SEC yield of 4.8%. And there are plenty of junk bond ETFs that have yields comparable to or well above what’s offered by HYG.
Speaking of junk bond ETFs, these funds are usually solid avenues for investors looking to tap high-yield corporate. Plus, plenty of those funds come with favorable costs. In fact, many professional investors have, in recent years, increasingly turned to junk bond ETFs over individual issues as a means of sourcing better liquidity.
So yes, there are plenty of perks to consider with junk bonds and the related ETFs. These benefits are often highlighted in declining-interest-rate environments.
“High-yield corporate debt has been one of the biggest beneficiaries of central-bank stimulus, which has squeezed spreads in better-quality bonds and forced investors to seek returns elsewhere,” according to Bloomberg.
Conversely, concerns about recent selling in other exotic corners of the high-yield market coupled with recession fears could sink some junk bond ETFs. Here are some to consider avoiding over the near-term.
Junk Bond ETFs: VanEck Vectors International High Yield Bond ETF (IHY)
Expense Ratio: 0.4% per year, or $40 on a $10,000 investment.
30-Day SEC Yield: 4.9%
The inclusion of the VanEck Vectors International High Yield Bond ETF (NYSEARCA:IHY) here isn’t to say this is a bad junk bond ETF. It’s not. But at this stage of the global economic cycle, it might be a tad late to be rushing to international high-yield debt.
Yet, it’s understandable that IHY’s 30-day SEC yield of almost 5% is tempting. That’s particularly true when sovereign yields in so many markets outside the U.S. are paltry.
IHY tracks the “ICE BofAML Global ex-US Issuers High Yield Constrained Index (HXUS), which is comprised of U.S. dollar, Canadian dollar, pound sterling, and euro denominated below investment grade corporate bonds issued by non-U.S. corporations in the major domestic or Eurobond markets,” according to VanEck.
The issue here is recession risk. Even if China’s slowing growth and the U.K.’s Brexit risk (a combined 20% of IHY’s roster), are ignored, there are still plenty of IHY geographic exposures flirting with recessions, including Brazil, Italy, Germany and Turkey. That quartet combines for over 23% over IHY’s roster.
If some of IHY’s major country weights can build some solid economic growth, it may be worth the risk. But for now, investors ought to take a wait-and-see approach.
First Trust Tactical High Yield ETF (HYLS)Expense Ratio: 1.16%
To be fair, HYLS being actively managed is an advantage in the current environment, because if credit conditions deteriorate, the fund’s managers can alter the portfolio.
Maybe HYLS’ portfolio will shift in the near future. For now, this junk bond ETF offers substantial credit risk. That’s an advantage in the right environment. But now probably isn’t the time to be drifting too far down the ratings totem pole. Over 60% of HYLS’ 286 holdings have one of the B ratings, which is low enough, but then there’s another 9% allocated to the highly speculative CCC category.
For now default rates are benign, supporting a long view of HYLS. But if default rates suddenly spike, this could be one of the first junk bond ETFs to be pinched. This year, HYLS’ modest out-performance of traditional junk bond funds isn’t justifying its high fee.
iShares Interest Rate Hedged High Yield Bond ETF (HYGH)
Expense Ratio: 0.53%
Interest rate hedged funds, such as the iShares Interest Rate Hedged High Yield Bond ETF (NYSEARCA:HYGH), are designed to thrive when rates rise. But that was last year’s news. Rates are declining this year.
Plus, investors don’t need to pay up for an actively managed product when rate risk isn’t the primary concern facing the domestic fixed income market.
HYGH is able to take exploit credit opportunities because its only holding is the aforementioned, unhedged HYG, (along with “short positions in interest rate swaps”). However, there’s still some credit risk involved in that passive fund. About 46% of HYG is rated BB, BB+, BB- or CCC.
Bottom line, HYGH is that it’s a decent fund, but there are better opportunities more suitable to the current environment.
As of this writing, Todd Shriber did not hold a position in any of the aforementioned securities.