An Appropriate High-Yield Bond ETF For Current Credit Environment

Amid a steepening yield curve and expectations that two interest rate cuts by the Federal Reserve will be followed by one or two more, investors are embracing high-yield corporate bond ETFs this year.

One of the more unique ideas to consider in the high-yield corporate bond ETF arena is the FlexShares High Yield Value-Scored Bond Index Fund (NYSEArca: HYGV).

HYGV seeks investment results that correspond generally to the price and yield performance of the Northern Trust High Yield Value-Scored US Corporate Bond IndexSM (the underlying index). The fund generally will invest at least 80% of its total assets (exclusive of collateral held from securities lending) in the securities of its underlying index. The underlying index reflects the performance of a broad universe of U.S.-dollar denominated high yield corporate bonds that seeks a higher yield than the overall high yield corporate bond market, as represented by the Northern Trust High Yield US Corporate Bond IndexSM.

HYGV traded slightly higher last week and that could be a sign of more upside to come for the junk bond fund.

“In the corporate bond market, the market action was relatively subdued as the main focus was on digesting third-quarter earnings reports, which thus far have been generally uneventful,” said Morningstar in a recent note. “On a week-over-week basis, the Morningstar Corporate Bond Index tightened 4 basis points to +116 and in the high-yield market, the ICE BofAML High-Yield Master II Index tightened 8 basis points tighter to +402.”

What’s Next

HYGV focuses on value by pursuing the higher risk/return potential found by concentrating on a targeted credit beta; utilizes Northern Trust Credit Scoring methodology to eliminate bottom 10% of issuers; performs liquidity assessment based on issuer’s debt outstanding, age and remaining time to maturity with the purpose of eliminating the bottom 5% illiquid securities; and intends to match the duration of a market cap weighted index (ICE BofAML US High Yield Index), while maintaining sector neutrality.

Data confirm that investors are flocking to junk bond funds in search of higher income and it’s possible HYGV will get a larger slice of that pie going forward.

“For the week ended Oct. 16, inflows into the high-yield asset class surged by $1.6 billion; however, this increase was driven entirely by $1.7 billion of net new unit creation across the high-yield exchange-traded funds, or ETFs, which was partially offset by $0.1 billion of withdrawals among the open-end high-yield mutual funds,” notes Morningstar. “Year-to-date inflows of $20.1 billion are heavily weighted toward the high-yield ETFs, which account for $15.0 billion of the inflows as only $5.1 billion of inflows are accounted for by the open-end mutual funds.”

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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.