More active funds have added high-yield bonds to supplement income in a low-yield environment, potentially overexposing investors to volatility. Instead, one can utilize exchange traded funds to better control credit risk.
According to a recent Wells Fargo study, almost 40% of funds in Morningstar’s intermediate-term-bond category held a level of high-yield exposure, which could diminish the diversification benefits of a traditional core-bond strategy, writes Aldo Ceccarelli, head of investments at Wells Fargo Funds Management, for InvestmentNews.
“It is important for plan sponsors and advisers to be aware that core bond strategies differ significantly,” Ceccarelli said. “Knowing the distinctions among the funds and to be able to identify the right attributes when selecting a style-pure core-bond strategy makes it possible to avoid taking on unintended exposure to high-yield debt.”
Specifically, Ceccarelli argues that true core-bond strategies have less than 10% in high-yield debt. These types of core-bond portfolios typically have lower correlations to equities and the S&P 500, providing investors with a good diversifer in times of market volatility.
“We found that the volatility of the high-yield index is nearly three times the volatility of the aggregate index,” Ceccarelli added. “The core-bond space as represented by the aggregate index has demonstrated a much more constrained level of risk and a significantly higher Sharpe ratio than have high yield and equities.”
Investors interested in taking a broad approach to the fixed-income market can choose from four ETFs that track the Barclays Aggregate Bond Index. For instance, the iShares Core U.S. Aggregate Bond ETF (NYSEArca: AGG) is the largest ETF to track the benchmark index. AGG has a 30-day SEC yield of 1.88%, 3,318 total holdings and an expense ratio of 0.08%. [Use Broad ETFs for Core Investment Positions]
The SPDR Barclays Capital Aggregate Bond ETF (NYSEArca: LAG) is more diversified with 9,054 components. However, it is more expensive with an expense ratio of 0.1535%. LAG also has a 2.02% 30-day SEC yield.
The Vanguard Total Bond Market ETF (NYSEArca: BND) has an even more diversified 16,177 components. BND has a 0.08% expense ratio and a 2.08% 30-day SEC yield.
Lastly, the Schwab U.S. Aggregate Bond ETF (NYSEArca: SCHZ) tracks 2,174 securities. SCHZ is the cheapest of the bunch, with a 0.06% expense ratio, and comes with a 2.03% 30-day SEC yield.
Since these four ETFs only track investment-grade debt securities, investors who still want to include some high-yield bonds can take a look at ETF options like the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), which has a 6.03% 30-day SEC yield, and iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG), which has a 5.56% 30-day SEC yield. However, like Ceccarelli warns, investors should not go overboard with their high-yield exposure. [Time to Jump for Junk Bond ETFs? Maybe]
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.