Investors are selling out of high-yield bond ETFs in 2022, due in part to the combination of rising interest rates and the geopolitical concerns tied to Russia’s invasion of Ukraine shifting risk tolerance levels. In addition, some fear that if earnings from corporate issuers slow due to a weakening global economic environment, their ability to meet debt obligations could lessen.

Despite representing a small slice of the overall ETF asset base, three high-yield ETFs were among the 10 funds with the highest net outflows year-to-date through March 25 while others incurred meaningful redemptions.

The iShares iBoxx $High Yield Corporate Bond ETF (HYG) remains the largest of the funds in the fixed income sub-category with $14 billion in assets, but the ETF has incurred $5.8 billion of redemptions since the beginning of the year, equal to 27% of its year-end 2021 assets. HYG’s outflows in 2022 were second only industry-wide to the SPDR S&P 500 ETF (SPY), which shed $21 billion but still had $411 billion in assets. 

Meanwhile, the SPDR Bloomberg High Yield Bond ETF (JNK) had $2.2 billion of net outflows, shrinking its asset base to $6.9 billion. But unlike SPY, which lost assets in part as advisors shifted to lower-cost alternatives like the Vanguard S&P 500 ETF (VOO) and the iShares Core S&P 500 ETF (IVV), the cheaper high-yield ETFs have also been out of favor in 2022.

The Xtrackers USD High Yield Corporate Bond ETF (HYLB) and the iShares Broad USD High Yield Corporate Bond ETF (USHY) also had a combined $3.1 billion in redemptions year-to-date. HYLB and USHY charge modest 0.15% expense ratios compared to 0.48% and 0.40% for HYG and JNK, respectively. Even the short-term-oriented iShares 0-5 Year High Yield Corporate Bond ETF (SHYG), which has a lower duration than HYG, had nearly $400 million of net outflows.

When building and maintaining asset allocation strategies, advisors often target a portion of their fixed income exposure to high-yield corporate bonds. The percentage allocated may depend on the risk tolerance of the investor and/or their age. For example, people in their 60s might have less exposure than their kids or grandkids. High-yield investments typically offer more reward potential but also incur more risk and volatility than investment-grade-rated corporate bonds and government securities. 

To compensate for the credit risk, HYG currently sports a 5.4% 30-day SEC yield, more than 3.5% for the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), and 2.3% for the iShares Core Aggregate Bond ETF (AGG). AGG primarily has a mix of investment-grade corporate bonds and Treasuries.

Meanwhile, rather than directly owning individual bonds issued by American Airlines or Ford Motor, ETFs provide advisors and end clients diversification across sectors and credit ratings with bonds from hundreds of issuers. For example, HYG owns more than 1,300 positions and has 54% of assets in BB, 34% in B, and most of the small remainder in CCC-rated securities to limit the risk of issuers defaulting on their debt.

Even as the Federal Reserve hikes interest rates further in 2022, high-yield bond ETFs can continue to play a key role within a portfolio. Indeed, HYG’s effective duration of four years is less than half that of LQD, indicating that it should hold up better amid rising rates. 

It is understandable why high-yield bond ETFs have declined to start 2022 and why some investors have rotated away in an effort to reduce risk profiles. However, before considering heading for the exits, understand what makes these funds different than other bond ETFs or owning bonds directly. In a well-diversified portfolio, high-yield bond ETFs provide attributes that ETFs tied to other investment styles cannot.

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