Be Careful With This Junk Bond ETF | ETF Trends

At first glance, the First Trust Tactical High Yield ETF (NASDAQ: HYLS), an actively managed ETF that tracks high-yield debt securities rated below investment grade, appears to be a tempting income-generating idea at a time when Treasury yields are low.

Indeed, HYLS’ yield of 5.35% is alluring and the fund has some history of outpacing passive rivals. HYLS’s outperformance may be attributed to the management team’s ability to adapt to shifting market conditions. For example, the ETF has targeted lower maturity debt securities to diminish the negative effects of rising rates and eschewed riskier energy and materials sector debt.

However, HYLS allocates 9% of its weight to bonds with the highly speculative CCC rating, a group that has recently come under some pressure.

“Maybe HYLS’ portfolio will shift in the near future. For now, this junk bond ETF offers substantial credit risk,” reports InvestorPlace. “That’s an advantage in the right environment. But now probably isn’t the time to be drifting too far down the ratings totem pole. Over 60% of HYLS’ 286 holdings have one of the B ratings, which is low enough, but then there’s another 9% allocated to the highly speculative CCC category.”

Not All Bad Thanks To Sector Weight

Importantly, energy and materials are absent from the ETF’s top sector weights.

Fixed-income observers have grown increasingly wary of energy and materials sector debt as the commodities market plunged over the past year. Many are concerned that we will witness greater defaults among energy producers as oil prices remain stubbornly low. Meanwhile, miners are also in a precarious situation after the demand for industrial metals, notably from China, declined as the global economy weakened.

“For now default rates are benign, supporting a long view of HYLS. But if default rates suddenly spike, this could be one of the first junk bond ETFs to be pinched. This year, HYLS’ modest out-performance of traditional junk bond funds isn’t justifying its high fee,” according to InvestorPlace.

HYLS, which holds 293 bonds, has total annual expenses of 1.16%, well above the average fee on passively managed junk bond ETFs.

For more information on the speculative-grade debt market, visit our junk bonds category

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.