Many have sought out speculative-grade debt securities to bolster yields in a low-rate environment but face growing default risks in light of the commodities rout. However, fixed-income investors may consider a smart-beta junk bond exchange traded fund that shows better credit risk exposure.
The PowerShares Fundamental High Yield Corporate Bond ETF (NYSEArca: PHB), which tracks the RAFI Bonds US High Yield 1-10 Index, leans toward slightly higher quality corporate debt securities than its major competitors.
The underlying Research Affiliates index implements a fundamental or smart-beta indexing methodology that focuses on four factors, including gross sales, gross dividends, cash flow and book value of assets for each issuer.
The end result is an index of company debt with higher credit ratings. Specifically, PHB’s quality allocations include some low-investment-grade BBB 16%, along with speculative-grade BB 58% and B 26%.
PHB excludes speculative-grade debt securities rated CCC and below, which carry much higher default risk, Scott Eldridge, Director of Fixed Income ETF Product Strategy at Invesco PowerShares Capital Management, explained in a phone interview.
In contrast, CCC-rated debt makes up 8.7% of iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and 13.9% of SPDR Barclays High Yield Bond ETF (NYSEArca: JNK).
However, due to tilt toward higher quality debt, PHB has a slightly lower yield than its competitors. PHB has a 4.31 year duration and a 5.22% 30-day SEC yield. HYG has a 4.17 year duration and a 6.93% 30-day SEC yield. JNK has a 4.35 year duration and a 7.16% 30-day SEC yield.
The lower default risk in PHB may also help explain its slight outperformance. Year-to-date, PHB dipped 0.5%, whereas HYG fell 2.6% and JNK dropped 3.7%.