By Clayton Fresk, Stadion Money Management
When analyzing the high yield ETF landscape, not shockingly it is dominated by two names – HYG and JNK. These have become the bellwether names for those looking to get broad high yield exposure. And while for some investors these are the ideal vehicles for the exposure and/or accessibility they desire, there are a plethora of other ETFs available that allow for a different exposure than a pure broad-based. While the aforementioned tickers make up nearly two-thirds of the assets under management (“AUM”) of this larger universe, there are rather significant assets in these ‘other’ names.
Short Term + Rate Hedged
This bucket of ETFS is by far the largest in terms of AUM outside the broad-based names. Based on my slicing and dicing, this bucket makes up a bit over 27% of the high yield AUM. A majority of the assets are in three names which focus on the short part of the curve (5-years and in). Some may argue based on the duration profile of the broad-based high yield universe that these short-term high yield names are not significantly different. While there is some truth to that argument, there are differences in issue characteristics that can provide some differentiated exposure between short term and broad-based high yield (outside of the obvious duration exposure).
I have also included in this bucket the series of Guggenheim’s Bulletshares. While the series itself is not purely short-term, given there are a couple of names that extend out beyond 5 years, a bulk of their assets reside in the shorter part of the curve. One of the benefits to the Bulletshares is they allow for a quite specific curve exposure. If an investor wanted only the shortest-term exposure, they could utilize only the 2018 ticker as example.
Another ETF is this group is HYGH, which hedges out any interest rate exposure, leaving the investor with more pure high yield spread with zero duration. While definitely not the same based on the security attributes, this type of exposure could be viewed as a compliment/replacement for bank loan exposure in that both are more pure spread/zero duration type.
Fallen Angel ETFs have been on many investors radars as of late due to some very strong performance. This classification of high yield is very interesting because it only includes issuers that were rated investment grade at issuance and then were subsequently downgraded to below investment grade. As such, the issuers still may have favorable fundamentals as compared to original issue high yield bonds. Additionally, as a group the Fallen Angels have a higher quality profile than broad high yield. A quick data pull had Fallen Angels at about 73% in BB-rated as compared to about 47% for the broad based names.
In the ilk of the Smart Beta revolution (particularly in equities but growing in fixed income), there are a handful of alternatively-weighted high yield bond ETFs in the market. The largest and oldest of these ETFs is PHB, which tracks a RAFI index. Because of the fundamental weighting, the corresponding portfolio will have a similar high-quality focus as Fallen Angels. But one difference is PHB explicitly states it will not invest in bonds rated lower than B, whereas Fallen Angels have that rating skew as a function of its issuer subset.
Related: ESG Has Arrived in Fixed Income ETFs
Some newer names (including some in registration but not yet in the market) will strive for similar low volatility/defensive HY exposure that is a byproduct of a higher-quality skew in exposure (or said otherwise eliminating lower-rated bonds/issuers that cause a large proportion of the volatility in the broad high yield market). Some do this via a factor-based approach, while some do this via an exclusionary process (i.e. eliminated lower rated or lower quality bonds/issuers). As the smart-beta trend continues to bleed over from equities to fixed income, I would expect the number of these alternative weighted ETFs to increase.
An alternative way to diversify U.S. high yield exposure is to go international. The first point of diversification is the differences in fundamentals between U.S. and non-U.S. high yield issuers. At rough glance, the international high yield marketplace has a higher quality skew, as measured by both its rating profile (higher BB weighting / lower CCC weighting) and its lower spread as compared to broad U.S. high yield. But as is the case with international equities, an investor also should take currency risk into consideration. Currency fluctuations can add an additional layer of volatility, but conversely can also enhance the diversification benefits. For investors who wish to avoid this currency effect, there are currency-hedged ETFs available, as well as forthcoming dollar-denominated-only ETFs (so including non-U.S. companies who have issued USD-denominated bonds).
Taking a cue from the primarily active high yield market in the mutual fund world, there are a few different active strategies available in the high yield ETF world. The largest of these names is HYLS, which takes a long/short investment approach. The fund can use the short side of the equation in treasuries (as a duration offset/hedge) and/or shorting corporate bonds (as a risk offset/hedge). Given the success of active high yield names in the mutual fund world, I could see this also being an area where future ETF growth could occur.
While broad-high yield can be a perfectly appropriate choice for many investors based on its characteristics, there is a differentiated subset of other high yield exposure in the market for investors who are looking for a bit more nuanced exposure.
Past performance is no guarantee of future results. Investments are subject to risk and any investment strategy may lose money. The investment strategies presented are not appropriate for every investor and financial advisors should review the terms and conditions and risks involved. Some information contained herein was prepared by or obtained from sources that Stadion believes to be reliable. There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained. Any market prices are only indications of market values and are subject to change. At the time of writing, Stadion held long positions in HYG. Any references to specific securities or market indexes are for informational purposes only. They are not intended as specific investment advice and should not be relied on for making investment decisions. RAFI Fundamental Index is a non-price-weighted index strategy that aims to deliver excess return versus the cap-weighted benchmark by using fundamental measures of company size to systematically rebalance against the market’s constantly shifting expectations. One cannot invest directly in indexes, which are unmanaged and do not incur fees or charges. Founded in 1993, Stadion Money Management is a privately owned money management firm based near Athens, Georgia. Via its unique approach and suite of nontraditional strategies with a defensive bias, Stadion seeks to help investors—through advisors or retirement plans—protect and grow their “serious money.” Contact Stadion at 800-222-7636 or www.stadionmoney.com. SMM-092017-801