Sagging oil prices and widening credit spreads are among the factors weighing on the high-yield corporate debt market this year, but investors can reduce some of the volatility associated with junk bonds with ETFs, such as the IQ S&P High Yield Low Volatility Bond ETF (NYSEARCA: HYLV).

HYLV tracks the S&P U.S. High Yield Low Volatility Corporate Bond Index. That index “is designed to measure the performance of U.S. high yield corporate bonds with potentially low volatility. The index is comprised of bonds from the S&P U.S. High Yield Corporate Bond Index and is a modified market value-weighted index with a 3% cap on any single issuer,” according to S&P Dow Jones.

Data confirm that HYLV’s benchmark is indeed reducing volatility, providing investors with some buffer as the coronavirus pandemic leads to increased angst in the corporate bond market.

“The S&P U.S. High Yield Low Volatility Corporate Bond Index outperformed its broad market high yield benchmark during each of these stress periods, including a 2.8% outperformance during the recent COVID-19 sell-off,” said S&P Dow Jones Indices in a recent note. “The defensive nature of the low volatility index has acted as a cushion during market sell-offs.”

Setting A Strong Precedent

Volatility rankings have acted as an early indicator of rating changes. After reviewing rating changes from B to BB and vice versa over a period from the 4th quarter of 1996 through the 2nd quarter of 2019, it was shown that a bond’s volatility ranking generally started to improve 25–30 months before the rating upgrade happened. Low-volatility bonds have also historically exhibited less credit risk than high volatility bonds.

Adding to the allure of HYLV in the current market environment is a low weight to energy issues. That sector accounted for less than 5% of the fund’s weight heading into this year, according to issuer data. That’s a plus at a time when the energy sector is rife with credit downgrades and potential defaults.

Speaking of sector weights, just 2.63% of HYLV holdings are real estate issues, a benefit when the sector is under stress due to mall and store closures.

“The S&P U.S. High Yield Low Volatility Corporate Bond Index consistently exhibited volatility levels lower than its broad-based high yield benchmark,” said S&P Dow Jones Indices. “In fact, its volatility levels fell between those of the investment-grade and high yield universes.”

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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.