The speculative-grade bond market is notoriously known for its illiquid nature. Consequently, fixed-income investors seeking to generate some extra yields through junk bond exchange traded funds may consider active options with managers monitoring the underlying market.
“Skilled active managers can generate higher and more persistent excess returns in illiquid asset classes, which are less efficiently priced,” according to Morningstar strategist Samuel Lee. “This is why I advocate active management for high-yield bonds, if you’re going to own them.”
For instance, the AdvisorShares Peritus High Yield ETF (NYSEArca: HYLD) and First Trust Tactical High Yield ETF (NYSEArca: HYLS) are two actively managed high-yield ETF options investors can consider.
HYLD is sub-advised by Peritus Asset Management. Timothy Gramatovich, CIO of Peritus, and Ronald Heller, CEO & co-founder of Peritus, both manage the ETF.
The managers have shifted toward short-term securities and the ETF currently has a 2.53 year duration, compared to a 4.12 year duration in the Barclays U.S. High Yield Index. HYLD also offers a very attractive 9.51% 30-day SEC yield. However, the fund comes with a 1.18% net expense ratio.
HYLS, on the other hand, takes a long-short approach. Specifically, the active ETF takes a 130% long position and includes a short position of between 0% to 30% of the fund’s net assets in an attempt to manage potential risks. The fund has a net average effective duration of 2.96 years, a 6.03% 30-day SEC yield and a 0.95% expense ratio.
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.