Investors looking to gain exposure to equities, but also want the income component of high yield bonds simultaneously may look to The High Yield ETF (NYSEArca: HYLD) as an alternative.
U.S. equities rallied in 2019, and then took a dive following the latest U.S.-China trade deal news, but investors are always on the hunt for income–they could find those opportunities in high yield. As such, lower equity returns for the rest of 2019 could translate to more interest in high-yield funds like HYLD.
“Investors who want equity exposure in their portfolios may consider adding high yield bonds instead of traditional equities,” the fund specified in an email. “Historically, the returns of high yield bonds have been highly correlated with those of equities, while exhibiting lower volatility and drawdowns. With the current economic expansion rapidly approaching record territory and equity valuations stretched, high yield may serve as an attractive substitute for part of an investor’s equity allocation.”
HYLD provides exposure to a high income investment strategy that selects a focused portfolio of high yield securities. Utilizing a value-based, active credit approach to the markets, HYLD primarily focuses on the secondary market where there is less competition and more opportunities for capital gains.
The Portfolio Manager relies on their own fundamental credit analysis with an emphasis on a company’s ability to pay back their debts with free cash flow. HYLD seeks to provide high income and diversification benefits to the income portion of a portfolio.
Furthermore, its correlation with the S&P 500 gives investors an alternative to traditional equities.
“Investors may contemplate using high yield bonds as a substitute for equities in their portfolio given the strong historical correlation between the two asset classes,” the fund noted. “The chart below indicates that the historical correlation of the Bloomberg Barclay’s US High Yield Index with the S&P 500 is 0.59. Thus, an investment in high yield bonds has given investors equity-like exposure in their portfolios.”
A volatile end to 2018 no doubt elicited a risk-off sentiment that permeated throughout the capital markets, causing high-yield bond funds to experience an aggregate one-month outflow of $1.45 billion, according to data from XTF. However, it appears investors could be turning a corner on high-yield thus far in 2019.
With bond market mavens warning investors of headwinds in the fixed income space like the possibility of inverted yield curve, rising rates and BBB debt sliding out of investment-grade, investors need to be keen on where to look for opportunities.
The tide could turn for high-yield bond ETFs, especially now that the Federal Reserve is sounding more accommodative with respect to interest rate policy. Following the fourth and final rate hike of 2018, the central bank is now taking a more cautious approach with rates, which could lead to static rates through the rest of 2019.
The central bank didn’t show much dynamism in 2018 with respect to monetary policy, obstinately sticking with a rate-hiking measure with four increases in the federal funds rate. That appears to have changed given the current economic landscape, and especially in the capital markets as Fed Chair Jerome Powell is now preaching patience and adaptability.
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