With some asset allocators recommending high-yield corporate debt over investment-grade fare, the FlexShares High Yield Value-Scored Bond Index Fund (NYSEArca: HYGV) is an example of an ETF ready for its turn in the spotlight.
HYGV’s index reflects the performance of a broad universe of U.S.-dollar denominated high yield corporate bonds that seeks a higher total return than the overall high yield corporate bond market, as represented by the Northern Trust High Yield US Corporate Bond IndexSM. The fund generally will invest under normal circumstances at least 80% of its total assets (exclusive of collateral held from securities lending) in the securities of its index.
Investment-grade and high-yield spreads spiked in March, but have since come back in and with central banks supporting bond markets, investment-grade bonds look less appealing when measured against junk rivals.
“The risk/reward balance now looks much less appealing: The extraordinary monetary policy support has already priced in, and IG is offering little buffer against risks such as rising rates due to its interest rate-sensitive nature, in our view,” according to BlackRock research. “High yield spreads have also narrowed sharply from late March (see the yellow line), yet there may still be room for further tightening, in our view, particularly as the economic restart gains steam.”
What’s Next for HYGV
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 the 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.
“Our stronger preference for high yield is also supported by fundamentals that appear disconnected from market pricing,” notes BlackRock. “The current pricing implies around 25% of the bonds on the Bloomberg Barclays U.S. Corporate High Yield Index could default over the next five years, our calculations showed.”
HYGV is significant at a time when many high-yield investors are still chastened by rampant credit downgrades. The weakness comes right after a record borrowing binge in recent years as many companies looked at the relatively low-rate environment as a cheap opportunity to borrow, with more investors willing to chase after speculative-grade debt for their more attractive yields.
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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.