Rising rates typically negative affect fixed-income assets. Nevertheless, investors can target high-yield exchange traded funds to help cushion against any pullback.
On the recent webcast, High Yield Solutions for a Rising Rate Environment, Fran Rodilosso, Head of Fixed Income ETF Portfolio Management at VanEck, argued that investors should consider high-yield fixed-income assets if the markets continue on course in an environment of fiscal stimulus under the Trump administration, monetary tightening in response to the growing economic outlook, rising inflation, tighter credit spreads and stronger U.S. dollar.
When seeking high-yield income-generating strategies, Rodilosso pointed to a number of options for various circumstances. For instance, if one is more amenable to higher risk, investors can consider something like fallen angel high-yield bonds to participate in the higher quality high-yield bond market, business development companies for exposure to loans to private companies and preferred securities for their attractive yield play.
For example, the VanEck Fallen Angel High Yield Bond ETF (NYSEArca: ANGL) was the first ETF to provide exposure to “fallen angel” bonds, speculative-grade debt securities that were initially issued with an investment-grade rating but were later downgraded to junk territory. Fallen angel issuers tend to be larger and more established than many other junk bond issuers. Rodilosso said that fallen angels have outperformed traditional high yield, investment grade and equity strategies and averaged less volatility than equity strategies.
The VanEck Vectors Preferred Securities ex Financials ETF (NYSEArca: PFXF) provides exposure to preferred securities, which may offer competitive yields with a higher payout than common stock and senior debt, has favorable tax treatment as distributions may be treated as qualified dividend income and are senior in structure or rank higher than common stock in the event of bankruptcy. Furthermore, by excluding financials, PFXF has offered similar yield to the broad preferred securities universe, provided greater diversification since financials make up almost three quarters of the broad preferreds universe and generated lower volatility historically than with financial preferreds.
Click here to watch the webcast On-Demand to earn CE Credit
If one is concerned about the direction of interest rates, there are ways to limit duration exposure to near zero with an interest-rate hedged high-yield ETF to participate in the corporate bond market while still limiting rate risk and BDCs that have exposure to floating rate loans.
The VanEck Vectors Treasury-Hedged High Yield Bond ETF (NYSEArca: THHY) is an interest rate-hedged or zero duration ETF that holds long-term speculative-grade bonds but also simultaneously shorts Treasuries or Treasury futures contracts to hedge against potential losses if interest rates rise. Consequently, this hedged high yield bond ETF could outperform non-hedged high yield bonds if interest rates continue to rise.
The VanEck Vectors BDC Income ETF (NYSEArca: BIZD) can also act as a high-yield alternative with low rate risk. BDCs act as an alternative to bank loan debt, helping smaller companies grow and profiting off the investments, which in turn would then help investors gain exposure to the growth and income potential of these privately held companies. Moreover, BDCs should also do relatively well in the kind of environment ahead where many expect an increase in interest rates. Since BDC loans are mostly floating rate – over 70% on average, the companies could earn more as rates rise.
Additionally, investors can look to international exposure as many global assets come with higher yields compared to their U.S. counterparts, including non-U.S. bonds, hard and local-currency denominated bonds, and corporate and sovereign bonds.
Investors who are interested in high-yield international bond options can also look at the VanEck Vectors International High Yield Bond ETF (NYSEArca: IHY), which tracks the BofA Merrill Lynch Global ex-US Issuers High Yield Constrained Index, an index of below investment grade corporate bonds issued by non-U.S. corporations in the major domestic or Eurobond markets. Investors who are allocated to only U.S. high-yield corporate bonds may be missing a significant portion of the global corporate high-yield market as international high yield corporate bonds have historically outperformed U.S. high yield corporate bonds, Rodilosso said.
Lastly, the VanEck Vectors Emerging Markets High Yield Bond ETF (NYSEArca: HYEM) holds a number of U.S. dollar-denominated bonds issued by non-sovereign emerging market issuers that are rated below investment grade, offering investors attractive yields. On the other hand, the VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) tracks local currency-denominated emerging market bonds.
Financial advisors who are interested in learning more about the fixed income market can watch the webcast here On-Demand.