The Low-Vol Concept Applied to High-Yield Bond ETFsThe low-volatility factor has been a popular way for investors to achieve improved risk-adjusted returns in the equities market, and IndexIQ recently applied the concept to a newly launched high-yield bond exchange traded fund.

ETF Trends publisher Tom Lydon spoke with Salvatore Bruno, Executive VP and Chief Investment officer of IndexIQ, at the Inside ETFs conference that ran Jan. 22-25, 2017 to talk about their newly launched IQ S&P High Yield Low Volatility Bond ETF (NYSEArca: HYLV).

“It is unique and different in the high-yield space,” Bruno said. “We’re taking the low-volatility concept that’s been applied successfully and documented by the academic research on the equity side for a number of years, so we’re taking that and applying it to a very liquid universe of high-yield corporate bonds.”

The high yield low volatility bond ETF tries to reflect the performance of the S&P U.S. High Yield Low Volatility Corporate Bond Index, which is comprised of U.S. dollar-denominated high-yield corporate bonds that have been selected using a rules-based methodology that identifies securities expected to have a lower volatility relative to the broader high-yield market.

“We use the concept that we developed called the marginal contribution to risk,” Bruno said. “What that does is it looks at the duration of each bond as well as the spread of each bond, and using those metrics we try to filter out the 50 percent most risky bonds in the universe so that you have the lowest risk high-yielding bonds in the universe.”

Each bond is ranked according to its marginal contribution to risk, or MCR, a measurement of the amount of risk a security contributes to a portfolio of securities. The measure is calculated using a bond’s duration and the difference between the bond’s spread and a weighted average spread of the bonds in the broader index universe. Those with a higher MCR will add more credit risk than debt with a lower MCR. The underlying index will only select the 50% of bonds measured to have the least credit risk based on their MCR.

Consequently, fixed-income investors are left with an ETF portfolio that has more quality, is more liquid and is less volatile than other high-yield bond funds.

“Our research has shown that you get about 25 percent reduction in volatility, and over long cycles – we have both up and down, you can get very similar return as a broad high-yield universe but, again, at half the volatility,” Bruno added.

HYLV’s credit quality exposure includes speculative-grade BB+ 25.4%, BB 37.1%, BB- 20.1%, B+ 7.6%, B 6.8% and B- 3.0%. In contrast, other high-yield, junk bond ETFs may include over 10% to the riskier CCC-rated debt securities.

Click here to read IndexIQ’s 2017 Outlook on ETF Trends and NYSE’s exclusive 2017 Market Outlook Channel.

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