High-Yield Bond ETFs that Protect Against Rising Interest Rates

April 15th at 6:41am by Tom Lydon

Some investors wary of potential interest rate risks but still yearning for income generating opportunities have loaded up on high-yield and low-duration bond exchange traded funds.

A perfect example of this trend is the recent popularity of PIMCO 0-5 Year High Yield Corporate Bond Index (NYSEArca: HYS) as investors hunt for junk debt ETFs that provide some protection from rising interest rates. The high-yield ETF has a shorter duration. HYS competes with SPDR Barclays Short Term High Yield Bond ETF (NYSEArca: SJNK).

Also, ETFs like the Vanguard Short-Duration Bond ETF (NYSEArca: BSV) and PowerShares Senior Loan Portfolio (NYSEArca: BKLN) have gathered over $1.6 billion in assets under management year-to-date, writes Eric Dutram for Zacks.

BSV has an average duration of 2.7 years and a 0.53% 30-day SEC yield. BKLN, which holds senior loans structured with floating rate interest payments based on the LIBOR rate, senior loans have 51 days to reset and comes with a 3.89% 30-day SEC yield. [High-Yield Bond ETFs Shrug Off Woeful Jobs Report]

“Investors are definitely still reaching for yield, but they’re clearly moving more aggressively toward the short end of the curve,” XTF executive Richard Radnay said in a Wall Street Journal article.

ETFs with short effective durations have been attracting greater attention as investors sought ways to hedge against interest rate risk with Treasury yields hovering around historical lows. Floating rate securities, as the name implies, allow interest rates on the debt to change along with the rest of the market.

Bond investors have started to look into low duration debt securities after Federal Reserve chief Ben Bernanke hinted at curbing asset purchases and raising rates if the economy strengthens.

While most ETF investors have honed in on the obvious high-income junk bond choices, the AdvisorShares Peritus High Yield ETF (NYSEArca: HYLD) has stayed relatively hidden from the spotlight, with $210.8 million in assets under management and an average 39,900 daily trading volume. The ETF has an effective duration of 3.2 years and a 8.27% 30-day SEC yield. The active fund comes with a 1.35% expense ratio. [High-Yield Bond ETF Paying 8% Takes Active Approach]

Dutram suggests that investors should not write off HYLD as a high-yield option, even with its slightly higher expenses.

In comparison, the iShares High Yield Corporate Bond ETF (NYSEArca: HYG) has a 3.89 year effective duration, 4.87% 30-day SEC yield and a 0.50% expense ratio. The fund is much larger, with $15.5 billion in assets under management and an average trading volume of 3.3 million shares.

On a performance basis, HYG has gained 2.3% year-to-date, compared to the 4.6% rise in HYLD, which suggests that the active management component in HYLD has brought value and capital appreciation.

ETFs tracking floating rate notes and senior bank loans have been popular recently as some investors position for higher interest rates. [Floating Rate ETFs]

However, speculation of a “Great Rotation” out of bonds has been off the mark. Treasury yields have actually been in rally mode with the 10-year yield falling below 1.8%. [PIMCO ETF Hits Lifetime High]

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.

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.