Speculative-grade, high-yield bond exchange traded funds have been among the most heavily traded fixed-income asset categories. While more investors have turned to junk bond ETFs, some may have noticed that the funds do not perfectly reflect benchmark indices.
Some fund managers point out that junk bond ETF returns are lower than underlying indices they track, the Financial Times reports.
For instance, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) underperformed its benchmark Markit iBoxx USD Liquid High Yield Index by 0.16% this year and by 0.58% on average annually since inception. The SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) underperformed its benchmark Barclays High Yield Very Liquid Index by 2.59% annualized since inception.
The junk bond ETFs are popular plays to provide quick and easy access to debt markets that most retail investors find trickier to trade. However, potential bond ETF investors should be aware that these funds do not perfectly track their underlying indices.
Potentially adding to tracking errors between the bond ETFs and the underlying benchmarks, liquidity in the primary debt securities market can affect an ETF’s performance. ETFs typically try to hold more liquid bonds and enact a sampling strategy where funds will only hold a sample collection that best represents the underlying index, which may result in a divergence in performance or so-called tracking error.
Additionally, ETF fees may also cut into overall performance. HYG has a 0.50% expense ratio and JNK has a 0.40 expense ratio. Matthew Tucker, head of Americas iShares fixed income strategy at BlackRock, attributes HYG’s trailing performance to the expense ratio.
David Mazza, head of research for ETFs at State Street Global Advisors, attributes JNK’s underperformance to transaction costs. When an ETF rebalances its portfolios to better track the underlying index, the fund must buy or sell debt securities. While iBoxx absorbs some of the transaction costs, Barclays indices does not, which may help explain JNK’s poorer performance to its benchmark.
Nevertheless, many investors are willing to look beyond these shortcomings as the junk bond ETFs provide a way to capture short-term, tactical plays on the high-yield debt market. Since ETFs trade like stocks on a stock exchange, anyone can access the funds through a normal brokerage account. [The Fed Can’t Faze Junk Bond ETFs]
“People are enamored by market timing and liquidity,” Krishna Memani, chief investment officer and head of fixed income at OppenheimerFunds, told the Financial Times. “Expecting ETFs to give you exact market returns is too much, but you get liquid exposure to the market.”
For more information on the speculative-grade debt market, visit our junk bonds category.
Max Chen contributed to this article
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.