The high yield low volatility bond ETF tries to reflect the performance of the S&P U.S. High Yield Low Volatility Corporate Bond Index, which is comprised of U.S. dollar-denominated high-yield corporate bonds that have been selected using a rules-based methodology that identifies securities expected to have a lower volatility relative to the broader high-yield market.
Specifically, each bond is ranked according to its marginal contribution to risk, or MCR, a measurement of the amount of risk a security contributes to a portfolio of securities. The measure is calculated using a bond’s duration and the difference between the bond’s spread and a weighted average spread of the bonds in the broader index universe. Those with a higher MCR will add more credit risk than debt with a lower MCR. The underlying index will only select the 50% of bonds measured to have the least credit risk based on their MCR.
In looking at back tested data with a base date of January 31, 2000, the underlying index generated improved risk-adjusted returns.
“The index demonstrates trend behavior similar to the benchmark S&P U.S. High Yield Corporate Bond Index, yet with less volatility,” Xie and Soe said in a note. “Cumulatively, the annualized return of the S&P U.S. High Yield Low Volatility Corporate Bond Index (at 7.12%) was 7 bps lower than that of the broader universe, but the ratio of return to volatility improved by 0.19 to 1.01 due to reduced volatility.”
By screening for the low-volatility factor in high-yield corporate debt, the low-vol focus has achieved its goal with reduced return volatility, improved performance in down markets than in up markets and diminished drawdown in stressed markets.
Potential investors, though, should keep in mind that the more conservative investment strategy will underperform the broader speculative-grade debt market during periods of strong bull rallies. Additionally, the defensive low-vol play also exhibited lower yields to achieve its risk reduction, compared to the broad-based high yield market.