Income seekers can consider a high-yield bond exchange traded fund strategy that generates attractive yields and still hedged potential downside risks ahead.
In the recent webcast, ETF Strategies for Managing Today’s Market Risks, Daniel Phillips, Director of Asset Allocation Strategy, Northern Trust Asset Management, and Bradley Camden, Director of Fixed Income Strategy, Northern Trust Asset Management, looked to the current volatile conditions and outlined a way for yield hunters to dip into the markets with a high-yield strategy that helps limit further downside risks.
The strategists argued that while high-yield bonds are a risk asset, they are one worth considering. Over the long-term global high yield, average monthly returns have been more or less equal to global equity monthly returns at 0.7%. While high-yield bonds may not generate the same kind of returns during a bull market, the bonds have given up less during downturns. For example, when global equities were negative with a -3.6% average monthly return during the downside, high-yield bonds only fell -1.2% on average per month.
The current market environment is also more supportive of the bond markets. The Federal Reserve is throwing everything, even the kitchen sink, in the economy. The central bank has enacted near-zero rates and unlimited bond purchases, including investment-grade and speculative-grade corporate debt for the first time, to support credit markets.
Meanwhile, the recent sell-off and distortions in the interest rates have widened spreads to levels not seen since the last financial downturn.
As more investors look back into high-yield bonds to generate attractive income in this lower-for-longer yield environment, one should note that not all high-yield bonds are the same. Higher quality or higher rated speculative-grade debt have performed better or given up less in this current downturn. For example, BB-rated junk bonds only fell -5.3% so far this year, compared to the -32.4% plunge for C- to D-rated debt.
Furthermore, sector performances have shown wide variations. Transportation and energy-related junk bonds have plummeted over 30% this year. Meanwhile, electric utility, technology, and insurance high-yield bonds declined less than 10%.
As the economic weakness continues, the strategists anticipate the highest number of fallen angels in a decade, with more borderline investment-grade companies being downgraded to high speculative-grade or so-called fallen angels.
The strategists also pointed out that the current market environment now has a greater quantity of higher quality high-yield or BB-rated speculative-grade debt. As of the end of March, 52% of the U.S. high yield market was rated BB, compared to 41% back two decades ago.
However, fixed-income investors are still faced with increasing credit risks as high yield default rates rise above their long-run averages.
The Right Way To Turn
Consequently, fixed-income investors may turn to a smart-beta junk bond ETF to strategy generate attractive yields and still hedge potential downside risks ahead through something like the FlexShares High Yield Value-Scored Bond Index Fund (NYSE: HYGV). HYGV utilizes a unique screen for high-yield corporate debt. The FlexShares High Yield Value-Scored Bond Index Fund tires to reflect the performance of the Northern Trust High Yield Value-Scored US Corporate Bond Index, which hones in on value with a proprietary credit scoring model that maximizes factor inputs for value while at the same time, effectively screens for quality and liquidity risk. The bond issuers are then fundamentally evaluated against current market conditions, with low-quality issuers precluded from the index.
The FlexShares High Yield Value-Scored Bond Index Fund may provide additional diversification benefits in multi-asset class portfolios through increased exposure to credit premia. It offers the potential for capital appreciation by identifying and investing in securities trading below their intrinsic value. In addition, the ETF could generate higher levels of income compared to legacy indices due to targeted exposure to Northern’s proprietary value factor and strategy construction.
Financial advisors who are interested in learning more about strategies to manage today’s market risks can watch the webcast here on demand.