How One Strategist Uses High Yield ETFs

Fixed income exchange traded funds were the dominant asset gatherers in the first quarter, but that trend reversed in April. Last month, ETFs hauled in $15.1 billion, more than half the year-to-date total, with equity funds leading the way.

Although the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) is the only bond fund among the top-10 ETFs in terms of 2014 inflows, some ETF strategists believe a focus on lower quality bonds is worth evaluating.

Philadelphia-based Clark Capital “starts with quantitatively derived macroeconomic analysis to determine which of the following asset classes is most appealing in light of the credit spread environment: Short-Term Treasuries, High Quality Debt (mostly Intermediate Treasuries and Investment Grade bonds) and Low Quality Debt,” according to a new research note by S&P Capital IQ.

“Clark believes the fixed income markets are at inflection point, where Treasury yields will stop going down and the risk of rising interest rates becomes a greater possibility. Rather than abandoning fixed income, the strategist thinks advisors should be focused on lower quality debt,” said S&P Capital IQ in the note.

Clark held two high-yield bonds ETFs at the end of April. S&P Capital IQ has a marketweight rating on the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG), the lone bond fund among the 10 worst ETFs for 2014 inflows. S&P Capital IQ has an overweight rating on the rival SPDR Barclays High Yield Bond ETF (NYSEArca: JNK). [Junk Bond ETFs Rally as Default Rates Plunge]

Clark notes there are important differences between the two ETFs.

“HYG holds more individual bonds than JNK (more than 900 compared to 700). Furthermore, while JNK’s 30-day SEC yield of 4.8% is higher than HYG, it also has less exposure to bonds rated BB and more exposure to bonds rated CCC or below, since they track different indices and have different risk profiles. Year to date, through April, JNK rose 3.45%, outperforming HYG’s 3.07% gain. However, in 2013, HYG’s 6.8% return was stronger than JNK’s 5.8%. Both ETFs have been stronger performers than the well-known Barclays Aggregate Bond Index, which focuses on U.S. government securities and investment-grade corporate bonds,” said S&P Capital IQ.

Although junk bonds are thought to be less sensitive to interest rate risk, JNK has a modified adjusted duration of 4.26 years while HYG has an effective duration of 3.95 years. Advisors looking for yield with junk bond ETFs have been turning to lower duration funds. [Short Duration Junk ETFs Gain Fans]

For example, the PIMCO 0-5 Year High Yield Corporate Bond (NYSEArca: HYS) and the SPDR Barclays Short Term High Yield Bond ETF (NYSEArca: SJNK) have seen combined 2014 inflows that are nearly equivalent to the almost $2.3 billion pulled from HYG.