Four Things You Should Know About High-Yield Bond ETFs

July 11th at 7:05am by Tom Lydon

Investors who are holding onto high-yield debt mutual funds may look for exchange traded fund options, instead. Still, one should consider the differences before making the switch.

In about five years, the high-yield ETF market has garnered $28 billion in assets, adding $12 billion over the past year alone, as investors hone in on the attractive 7% yields, reports Steven Rosenbush for The Wall Street Journal.

Moreover, default rates on speculative-grade debt has declined to 2.2% in May since the height of the financial credit crisis when defaults were at about 13.7% in 2009.

“There is strong—very strong—growth in high-yield ETFs, which isn’t surprising,” says Morningstar analyst Timothy Strauts. [When to Consider Getting Aggressive in High-Yield ETFs]

When making the choice between high-yield bond ETFs or mutual funds, Rosenbush points to four factors:

  • The ETFs are passively managed and pegged to an underlying benchmark index. Although, financial adviser Lewis J. Altfest argues that the high-yield bond market is rather inefficiently priced and there are more opportunities to beat the market through active management.
  • Since the ETFs act to passively reflect an index, the costs are significantly lower. The average net expense ratio of the 630 high-yield mutual fund share classes tracked by Morningstar is 1.16%.
  • Mutual funds may only be traded at the end of the day based on the net asset value of the holdings, whereas the ETFs are traded throughout the day. While not as big of a problem now as before, the ETF’s price may exhibit small spreads on the NAV, usually one cent difference.
  • Since most ETFs employ a form of sampling technique where they would only take a selection of securities from the underlying index, the ETFs may not perfectly track the benchmark – the phenomenon is also known as tracking error; however, the fund’s expense ratio may also account for the disparity.

The largest high-yield bond ETFs include:

  • iShares iBoxx $ High Yield Corporate Bond Fund (NYSEArca: HYG)
  • SPDR Barclays Capital High Yield Bond ETF (NYSEArca: JNK)
  • PowerShares High Yield Corporate Bond Portfolio (NYSEArca: PHB)
  • PIMCO 0-5 Year US High Yield Corporate Bond Index Fund (NYSEArca: HYS)

For more information on high-yield debt, visit our high-yield bonds category.

Max Chen contributed to this article.

Full disclosure: Tom Lydon’s clients own HYG and JNK.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.