If interest rates were to quickly rise, high-yield index-based bond ETF investors may find it costlier to sell-off their positions as notoriously low liquidity in the speculative-grade debt market could cause problems for the ETFs. [Rate Risk Raises Liquidity Concerns in Junk Bond ETFs]
Lee points out that liquidity-screen junk-bond indices have fallen behind the overall junk-bond market by almost 2% on an annualized basis – most junk bond indices may not be perfectly reflected due to the illiquidity of many bonds.
“With a few exceptions, it’s a terrible mistake to own a passive fund that tracks an illiquid market,” Lee added. “Most investors are better off sticking to high-quality stocks and bonds and tactically allocating to junk when valuations warrant.”
For more information on speculative-grade debt, visit our junk bonds category.
Max Chen contributed to this article.