ETF Trends CEO Tom Lydon discussed the Xtrackers USD High Yield Corporate Bond ETF (HYLB) on this week’s “ETF of the Week” podcast with Chuck Jaffe on the MoneyLife Show.
HYLB offers broad exposure to “junk” bonds — debt issued by borrowers with a higher risk of default. For taking on the added risk, investors are rewarded with higher yields than those offered on ultra-safe U.S. Treasuries or investment-grade debt issued by the most creditworthy companies. ETFs offer quite a few high-yield options, including active management, so-called “smart” indexing, and even an ETF that screens junk debt based on environmental, social, and government criteria.
With a divided Congress and Joe Biden taking the lead, junk bonds enjoy a return of risk appetite among yield-starved, fixed-income investors. There’s been a +2.7% 1-week return. Junk bonds saw one of their strongest weekly performances since June.
Fixed-income investors, who are normally risk-averse, have largely missed out on the rebound in high-yield bonds. Short interest as a percentage of shares outstanding on the $26.5 billion iShares iBoxx High Yield Corporate Bond ETF (HYG) climbed to over 25% on Tuesday, the highest level since April, according to data from IHS Markit Ltd. Many investors trimmed risk exposure heading into the elections.
A Bullish Case For High-Yield Credit
Valuations are still attractive despite the rally. Federal Reserve is committed to keeping interest rates lower for longer in support of a fledgling economic recovery. No “blue wave” or Democrat control over Congress and the White House could mean a smaller stimulus package, so the Fed will have to make up the difference with loose monetary policy.
The Fed is also committed to supporting the credit market, buying corporate bonds and related ETFs for the first time ever this year. The Fed’s assistance at the height of March’s coronavirus turmoil helped dramatically compress junk bond spreads to Treasuries.
Long-term data for some of these high-yield sectors suggests that such investments can be worth the risk. Looking at all high-yield bond mutual funds over the past 30 years, If you are disciplined and avoid cashing out at the wrong time, high-yield debt can pay total returns near to those of U.S. stocks.
Since 1990, the average high-yield debt fund has delivered an average annual return of 7.1% with a volatility of 7.7%. Compare this with the average short-term U.S.-bond fund, which delivered 3.8% with a much lower volatility of 1.5% over the same period. High-yield bonds may look a lot more like equities than debt. Over the same period, since 1990, the S&P 500 delivered an average annual return of 7.8% but with a high volatility of 14.5%
However, short-term risks abound. In the middle months of 1990, the average high-yield debt fund lost 13% of its value. In one month in 1998 (August) the average high-yield fund lost 7% of its value, and in June 2002 the average fund lost 8% of its value. The financial crisis of 2008-09 came: Over the full year of 2008, the average high-yield debt fund lost 25% of its value, including a drop of more than 15% in October alone.
At least these short-term risks aren’t always correlated with stock downturns. When the dot-com bubble burst and U.S. equity markets slid, high-yield funds barely moved and actually finished higher for the year in 2000
The end takeaway? For an investor with a long investing time horizon, high-yield debt might be a good way to enhance the portfolio. For those investors who are seeking safety and low volatility, and can’t take the short-term hits to their wealth, you may want to skip this asset class
Listen to the full podcast episode on the HYLB ETF:
For more podcast episodes featuring Tom Lydon, visit our podcasts category.