High Yield Bond ETF (sometimes known as Junk Bonds) can be an important part of the investment portfolio by improving diversification and returns. Unlike dividend ETFs which focus on dividend income stocks. High yield index funds provide a mix of equity and bond like characteristics high yield bonds provide capital gains and income for the investor. Similar to Emerging Market Bond ETFs High Yield ETFs is a high risk asset class for investors that leans towards the risky end of investment spectrum.
The 2 largest High Yield Bond ETF are iShares iBoxx $ High Yield Corporate Bond Fund (HYG) and SPDR Barclays Capital High Yield Bond ETF (JNK). Both High Yield Bond ETFs are index trackers tracking the iBoxx $ Liquid High Yield Index and Barclays High Yield Bond Index respectively. For investors it can be a low cost options where the annual expense ratio averages 0.50% per year.
The critical criteria in the evaluation of the best high yield ETF is its returns and risk of the underlying bond portfolio.
The chart below shows the performance of these 2 high yield bond ETFs over the last 5 years. Current yield shows the income yield for JNK and HYG to be very similar. The total annualized yield based on the annualized rate of the most recent dividend payment (for high most bond ETFs dividends representing bond coupons received are paid monthly).
On a capital return and income yield comparison, the appreciation JNK and HYG over 5 years presents a very similar picture.
Investors should be aware that although the ETF return and yield is the most important driver of the investment decision process of selecting the best high yield ETF. The importance of credit risk should not be ignored.
Two primary drivers of bond return and risk over time can can be attributed to the maturity (interest rate term structure) and credit quality (risk of the default) of the underlying bonds in the portfolio. These same factors applies to also to the high yield bonds.
There is similar likeness in the maturity profile of the high yield bonds in the ETF. As the primary fundamental difference is its greater credit risk.
The average maturity of the bonds issued are typically much lower than normal bond ETFs (the largest corporate bond ETF – iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) has a duration of 7.4 years and average maturity of bonds in the ETF at 14 years and expense ratio of only 0.15%).
Using the same metrics. JNK have a typical duration of 4 years with the average maturity of 6 years and HYG’s duration and average maturity of bonds close to 4 years on both scales.
The higher duration of the JNK can be seen from the breakdown of portfolio maturity below where it has a higher weighting in the 5 – 10 year maturity band by almost 10% to HYG.
From comparing the underlying quality of the underlying credit of the high yield fixed income ETF. The result shows that quality of the bonds in JNK’s portfolio lean toward relative higher end of the high yield bond risk spectrum. It has no allocation to BBB or higher, underweight BB rating by 7% to HYG and overweights the B rated credits by almost 16%.
The investors can now see the primary factors that contributed to the better return of JNK over HYG over the last 5 years. As is with everything in the markets, there is no such thing as a free lunch. JNK outperformed HYG through having longer dated high yield bonds in the ETF and relative underweight in bonds that are closer to investment grade ratings.
Potential risk of higher duration with everything else remain the same is a portfolio much more sensitive to changes in interest rates. The price of Gold and silver are also sensitive to changes in interest rate expectations. If the market expect the rates to finally rise and price in interest increases. JNK’s higher duration and credit risk could result in returning the outperformance it had vs HYG.
These factors presents a clear distinction between the 2 largest high yield ETFs. For the ETF to be considered the best high yield ETF. The inventor need to ask themselves when they consider in the high yield ETF, Risk or Return?