High-yield bonds exhibit a similar nature to stocks as the equity-like debt securities are issued by businesses with lower credit ratings, so their likelihood of being repaid in full will fluctuate with the business cycle, Abby Woodham, ETF Strategist at Deutsche Asset Management, and Robert Bush, ETF Strategist at Deutsche Asset Management, said in a research note.
“High yield tends to trade in an ‘equity-like’ manner, rallying when times are good and falling when economic conditions call into question firms’ ability to service their debts,” the Deutsche strategists said.
While high-yield bonds may move more like stocks, potential investors should keep in mind that equities still show greater risk than the fixed-income asset. The Deutsche strategists pointed out that the historical average correlation between equities and high yield was 0.37, a relatively low level that could still allow investors to diminish overall risk in their portfolios.
When assessing risk in the high yield market, investors should watch for the credit spread and duration.
Credit spread indicates the additional yield above Treasury bonds that investors demand to take on additional risk inherent in debt of similar maturity, so the higher the spread or greater the yield would imply higher risk and fuel default concerns.
Duration is seen as a weighted average time in years for an investor to receive cash flow and also seen as a gauge of interest rate sensitivity. Bond funds with higher duration would have a greater sensitivity to changes in rates, whereas low duration funds have a smaller sensitivity to rate hikes.
In the fixed-income market, bond ETFs have been a very disruptive force that has allowed anyone to quickly and easily access exposure to debt securities. According to a recent Greenwich Associates survey, the three most popular reason for utilizing high-yield bond ETFs were low trading costs, operational simplicity and speed of execution.
Most bond ETFs passively and closely track an underlying index, trades on a stock exchange with reasonable spreads and allows investors to easily and cost efficiently access a broad index of debt securities.
For example, the recently launched Deutsche X-trackers USD High Yield Corporate Bond ETF (NYSEArca: HYLB) will try to reflect the performance of the newly launched Solactive USD High Yield Corporate Total Market Index, a market value weighted benchmark designed to mirror the performance of high yield corporate bonds issued in U.S. dollars.
For more information on the high-yield bond market, visit our high-yield bonds category.