Recent data indicate that investors have been flocking to high-yield corporate bond funds in recent months, presumably because default rates remain low and the Federal Reserve is lowering interest rates. Still, some investors may want to take a more conservative approach to junk bonds. The Xtrackers Low Beta High Yield Bond ETF (NYSEArca: HYDW) is an ETF that helps with the objective.
HYDW holds more than 400 junk-rated bonds and follows the Solactive USD High Yield Corporates Total Market Low Beta Index. That benchmark includes junk-rated debt that exhibits lower overall beta to the broader high-yield bond market. Consequently, the portfolio is comprised of lower-yielding junk bonds that show a lower beta.
Of course, there are risks to consider with junk bonds. Even if default remains low, credit spreads can widen during recessions, causing these bonds to lag. The trade-off is that investors are compensated for the risk with higher yields, but HYDW looks to make that trade-off more compelling by reducing volatility.
“While the removal of the highest-yielding securities may limit the fund’s return potential, it also reduces volatility and potential for losses,” said Morningstar in a recent note. “This should be a more effective approach than simply removing the lowest-rated bonds because market prices, and thus yields, are usually quicker to pick up changes in credit quality than the ratings agencies.”
Spotlighting Interest Rate Risk
The current interest rate environment spotlights the interest rate risk associated with traditional junk bond funds, but some ETFs address that risk while keeping investors involved with relevant credit opportunities.
HYDW’s “investment universe consists of USD-denominated corporate issuances with between one and 15 years until maturity and at least $400 million in total face value,” notes Morningstar. “An issuer must have at least $1 billion in total debt outstanding. Bonds are weighted by market value, and there is a 3% issuer cap. The index is rebalanced monthly. After the eligibility pool is set, the 30-day moving average yield-to-worst is calculated and issues with yield-to-worsts higher than their category medians’ are removed.”
The $149.33 million HYDW holds 478 bonds and had a yield to worst of 3.49% and a modified duration of 2.40 years at the end of the third quarter.
“Yield-to-worst is the lesser of the yield-to-maturity and the yield-to-call. These metrics estimate the future return of a bond, effectively acting as measure a bond’s internal rate of return. The yield is averaged over 30 days, smoothing any short-term blips. If data is not available on an issue, it is left out of the index,” according to Morningstar.
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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.