The high-yield segment may provide more diversification benefits than many realize. Carlson singled out the low correlation high-yields have exhibited against equities, investment-grade fixed income and interest rates. The Bloomberg Barclays High Yield Index has a 0.715 correlation to the S&P 500 Index – a 1 reading would reflect perfect correlation. The high yield index also has a 0.264 correlation to the Bloomberg Barclays U.S. Aggregate Index and a -0.227 correlation to the Bloomberg Barclays U.S. Treasury Index, reflecting its low correlation to traditional fixed-income asset exposures.
At FlexShares, Carlson argued that investors should focus on yield value. Similar to the equities market, fixed-income assets also exhibit factor characteristics. Examining the returns from style factors versus the Merrill Lynch High Yield US Corporate Bond Index from 2003 through 2016, the Value style has been the best performing factor, followed by quality and low volatility.
Furthermore, the coupon return is also seen as an important factor in high yield investing as the yield carry drives 111% of the return of the Bloomberg Barclays U.S. High Yield Index.
A Unique Screen for High-Yield Corporate Debt
To help capitalize on these factors in the high-yield segment, investors can look to the recently launched FlexShares High Yield Value-Scored Bond Index Fund (NYSE: HYGV), which utilizes a unique screen for high-yield corporate debt.
The FlexShares High Yield Value-Scored Bond Index Fund tries to reflect the performance of the Northern Trust High Yield Value-Scored US Corporate Bond Index, which hones in on value with a proprietary credit scoring model that maximizes factor inputs for value while at the same time, effectively screens for quality and liquidity risk. The bond issuers are then fundamentally evaluated against current market conditions, with low-quality issuers precluded from the index.
The ETF 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.
Financial advisors who are interested in learning more about yield-generating strategies can watch the webcast here on demand.