The Indexing Quirks of Junk Bond ETFs

Some investors may have noticed deviations in the way junk bond exchange traded funds track benchmark indices. However, the perceived discrepancies in their respective tracking performances may be a result of indexing quirks.

The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) are the two popular junk bond-related ETFs, with a combined $25 billion in assets under management. HYG tries to reflect the performance of its benchmark Markit iBoxx USD Liquid High Yield Index. JNK tracks the Barclays High Yield Very Liquid Index.

“After adjusting for its 0.50% expense ratio, HYG actually outperforms its benchmark on a gross basis,” writes John Gabriel, a strategist for Morningstar’s manager research team. “On the other hand, JNK appears to lag its index by a relatively wide margin – a gap far too large to be explained only by its 0.40% expense ratio.”

Specifically, comparing HYG’s performance to its benchmark, the iShares ETF has exhibited a -0.49 percentage point difference year-to-date and a -0.21 percentage point difference for the past five years.

In contrast, comparing JNK’s performance to its underlying index, the State Street fund showed a -1.46 percentage point difference year-to-date and a -1.13 percentage point difference over the past five years.

Contributing to the slight variations in the ETFs’ ability to track their benchmarks, the two fund providers follow different portfolio construction and economic exposures, along with varying costs and tracking efficiency. Additionally, JNK has a greater liquidity constraint, setting minimum outstanding face value on debt securities at $500 million, compared to the $400 million limit in HYG.

However, the main reason JNK is showing wider tracking errors may be due to the different indexing methodologies.