With the junk bond market still a source of some controversy, income investors may want to consider fresh approaches, such as 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 seek a higher yield than the overall high yield corporate bond market, as represented by the Northern Trust High Yield US Corporate Bond Index.
“Over the long term, there should be a positive relationship between credit risk and returns. Investors expect to be compensated for bearing credit risk,” writes Morningstar analyst Alex Bryan in a recent note. “Otherwise, no one would take it. Understanding this, lower-rated bond issuers tend to offer higher yields to attract investors.”
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.
“Lower-rated bonds tend to offer higher yields than those with higher ratings,” notes Bryan. “This may be because they are trading at a deep discount to par value, offer a high coupon rate, or some combination of the two. This can make them attractive to income-oriented investors, who prioritize current income over capital gains, sometimes to the detriment of total returns.”
HYGV offers investors a quality-based approach for accessing the income and potential return advantages of high-yield corporates. Adding to the case for the FlexShares ETF is that its strategy isn’t entirely dependent on credit ratings.
“Credit ratings are a good starting point for identifying higher-quality high-yield bonds, but they’re probably not the most effective screen. Market prices tend to move faster than credit ratings. They usually start to decline ahead of rating downgrades and appreciate with improving fundamentals that often precede rating upgrades,” according to Bryan.
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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.