With the Federal Reserve backstopping the high-yield corporate bond market, it may be difficult to find a compelling combination of value and yield, but the FlexShares High Yield Value-Scored Bond Index Fund (NYSEArca: HYGV) remains a compelling option.
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.
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. Regulators and economists have warned that the debt market for high-risk companies may have become overstretched since the financial crisis of 2008.
Time for HYGV
Junk bonds are also sensitive to interest rate changes, meaning the Federal Reserve’s plans for lower rates should benefit the asset class. However, if the economy slows, credit spreads can widen, potentially hampering traditional high-yield debt strategies in the process.
“The Fed’s bond-buying program has brought down the yield on corporate bonds, as the effective yield for junk-rated borrowers is now hovering near 5.6%, down from its 2020 high of 11.4% on March 23,” according to FlexShares. “However, FlexShares believes there’s still opportunity to be found in the sector and it should be an allocation in most portfolios. With its proprietary credit scoring model focused on the value factor, FlexShares is looking to maximize risk-adjusted yield while remaining duration neutral and well-diversified.”
Specifically, high-yield bonds, like their names suggest, provide opportunities for enhanced yields. Since 1994, the high yield bond market has exhibited an average spread of 509 basis points above Treasuries.
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.
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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.