One of the few drawbacks of the nascent exchange traded fund industry is that there aren’t many options that have accumulated a long performance record to boast about. However, this is slowly changing as the industry grows, with one high-yield junk bond ETF celebrating its 10-year anniversary.
The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG), which began trading on April 4, 2007, just celebrated its 10th year of trading. This milestone provides 10-years of real time results for financial advisors and institutional investors to look back upon, which may further help the ETF growth and accumulate greater investment interest.
In its decade-long existence, HYG has showed a solid history of outperformance, returning a 5.6% average annualized return over the period. In contrast, the benchmark Bloomberg Barclays US Aggregate Bond Index showed an average annualized return of 4.3% over the past 10 years. Over the past year, HYG also increased 13.3%, compared to the Agg’s 0.4% gain.
The high-yield bond ETF has also more or less mirrored its underlying index over the 10-year period, providing consistent returns to those interested in the speculative-grade debt market.
“Since inception HYG’s annualized performance has been within 4 basis points of its index after fees,” according to iShares. “Its tight tracking stretches over a volatile period that included the 2008 financial crisis, the U.S. Treasury downgrade, European sovereign crisis and the collapse in oil prices.”
Looking ahead, many fixed-income investors are concerned about the Federal Reserve’s rising interest rate outlook, with many expecting at least two more hikes later this year. However, the rising rate environment won’t faze high-yield junk bonds.
Junk bonds typically exhibit “equity-like” characteristics, strengthening during periods of higher growth in the U.S. Stronger growth translates to less credit risk, or defaults in these speculative-grade debt securities. Heavily leveraged speculative-grade energy companies also appear stronger along with the rebound in crude oil prices – higher oil prices means less risk of defaults in the U.S. energy sector, which makes up about 15% of the high-yield market.
Moreover, some are looking at high-yield bonds to help cushion against any pullbacks associated with rising rates. For instance, HYG comes with an attractive 5.22% 30-day SEC yield, which may help offset any weakness associated with rising rates.
History has also shown that high-yield bonds have exhibited a positive correlation to rate changes, according to S&P Dow Jones Indices’ data. High-yield bonds typically exhibited positive returns when government bond yields rose. In contrast, investment-grade debt showed a negative correlation to interest rates.
In recent years, some market observers have grown wary of the potential liquidity risks associated with ETFs, especially in the event of a sudden sell off – some are concerned that the ETFs may not be able to be efficiently price in the event or heavy redemptions as the underlying junk bond market is notoriously known for illiquid nature. However, iShares noted that 84% of HYG’s trading is on the stock exchange, without a bond needing to be traded. HYG is becoming the go-to junk bond alternative as large traders increasingly look to the liquid ETF as an alternative to the illiquid underlying market.
“With over $750 billion in trades to date, HYG has become a robust source of liquidity for high-yield investors,” according to iShares. “HYG an provide an alternative venue for liquidity when the bond market is closed or impaired.”
Full disclosure: Tom Lydon’s clients own shares of HYG.
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.