How to Reduce High-Yield Bond Risk | ETF Trends

Investors looking to mitigate some of the risk associated with high-yield corporate bonds may want to consider fundamentally-weighted exchange traded funds, such as the WisdomTree Fundamental US Short-Term High Yield Corporate Bond (NasdaqGM: SFHY).

SFHY seeks to track the price and yield performance of the WisdomTree Fundamental U.S. Short-term High Yield Corporate Bond Index. Under normal circumstances, at least 80% of the fund’s total assets will be invested in component securities of the index and investments that have economic characteristics that are substantially identical to the economic characteristics of such component securities. The index is designed to capture the performance of selected issuers in the short-term U.S. non-investment-grade corporate bond market that are deemed to have favorable fundamental and income characteristics.

As its name indicates, SFHY is a short-term junk bond ETF. The fund’s effective duration of 2.21 years is well below what is found on traditional high-yield bond ETFs. Although SFHY lowers duration risk, that does not mean it reduces investors’ income profiles as highlighted by a 30-day SEC yield of 6.24%.

“The HY corporate market, as represented by the Bloomberg Barclays U.S. Corporate High-Yield Index, experienced a bit of a whipsaw effect last year,” said WisdomTree in a recent note. “The market saw positive, albeit modest, gains through the first three quarters of last year, as spreads remained low to flat. However, the fourth quarter saw a drop-off across all classes, and market performance took a significant hit, ending the year in negative territory.”

What’s next for junk debt

Market observers are growing more bullish on the junk debt category. Wells Fargo raised its high-yield total return forecast to 9.9%, compared to a 6% to 7% call last year, based on the attractive starting yield, fundamental backdrop and uptick in issuance as positive drivers, Bloomberg reports.

“We continue to advocate for a more intuitive way of accessing the market. By screening based on issuer fundamentals, our approach to credit can effectively target bonds that exhibit favorable fundamentals while presenting opportunities for income and screen out those that don’t,” according to WisdomTree. “WisdomTree has helped pioneer this market by creating an entire suite of fundamentally weighted corporate bond ETFs. One fund in the suite that we are very excited about moving forward is the WisdomTree Fundamental U.S. Short-Term High Yield Corporate Bond Fund (SFHY).”

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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.