Exchange traded funds (ETFs) that focus on junk bonds are an efficient way to access this area of the market without a lot of unnecessary expenses.

ETFs outdo the actively managed mutual fund because they hey have lower expense ratios, lower cash levels, lower turnover, and they track a highly structured index, expalins Robert Huescher for Advisor Perspectives. However, there can be some points of consideration with high-yield bond ETFs that investors might want to be aware of.

Huebscher points out that the iBoxx $ Liquid High-Yield (HYG) is the default proxy for the sector, and it holds approximately 50 highly liquid bonds.  But holding only 50 bonds might not be as much diversity as one desires. On a good day, these bonds might trade once, and most of the time they don’t trade at all. There are other funds available, too, that have a greater number of holdings if you seek more diversity:

• PowerShares High Yield Corporate Bond (PHB): It has 53 holdings and is still fairly new. The fund uses a quantitative overlay to choose issues with the best credit quality.
• SPDR Barclays Capital High Yield Bond (JNK): Its has 120 holdings and is otherwise fairly similar to HYG.

One issue to be mindful of in the ETF bond market is liquidity problems, and they’re especially heightened in the high-yield bond segment. Matt Hougan for Index Universe was quoted as saying that bond ETFs have a challenge finding the happy medium between liquidity and diversity.

Huebscher notes that no matter what, investors should always be mindful of the true nature of the risks they’re taking. It’s not possible to know the credit of every issuer within a fund, and diversification doesn’t necessarily eliminate the risks. Make sure you understand what you can handle before jumping in.

• iBoxx $ Liquid High Yield Junk Bond (HYG): down 10.8% year-to-date; yields 11.3%

• Barclays High Yield (JNK): down 7.2% year-to-date; yields 14.9%

Tags: Bond ETFs, ETF 101, HYG, JNK, Junk Bonds