Blue HavenBonds

High yield ETFs are particularly attractive right now

By September 8, 2019 No Comments

Central banks around the world are lowering interest rates. The result has been a global bond rally that has pushed bond prices higher, and yields lower. This is making high yield ETFs particularly attractive right now. Fixed income investors generally receive the benefit of predictable interest payments and low volatility. But as more investors accept negative yields, they go from receiving payments to making payments. As such, they’re now betting on a continued rise in bond prices more than anything else. For if the bond they own doesn’t rise in value enough to offset their negative yield, they will lose money on their investment.

If this sounds backwards, it’s because it is. Never before have we seen a bond market like this one. The idea of buying a security with the hope to sell it at a higher price is better suited for investors in stocks. We still believe in the traditional idea of receiving interest for the bonds we hold. But it’s getting harder to find options that match this goal. As yields have fallen, one place we’ve been watching more closely is short-term high yield corporate bonds.

Two high yield ETFs to consider

The two biggest players in this space are State Street Global Advisors with their SJNK ETF and iShares by BlackRock with their SHYG ETF. Both ETFs are liquid and focus on high yield corporate bonds with 0-5 years until maturity. Here’s a quick snapshot view of each:

Symbol SJNK SHYG
Expense Ratio 0.40% 0.30%
AUM $3 Billion $3.13 Billion
30-day SEC yield 5.60% 5.47%
Duration 1.77 1.86
Weighted Avg Maturity 3.38 Years 2.15 Years

On the surface there isn’t much different about these two ETFs. They both do a good job providing exposure to the high yield corporate bond market. SJNK is 10 bps more expensive, but it makes up for that by paying 13 bps more in interest. Both ETFs have low duration, which is attractive to us in the current interest rate environment. The biggest difference is in the weighted average maturity. SJNK has significantly more exposure to farther dated bonds than SHYG does. And that fact matters greatly to us in a slowing economy.

Be mindful of credit risk

The greatest risk in short-term high yield bonds is credit risk. That is the risk that the corporations will default on their bonds and not be able to make payments. Anytime the market gets concerned about an economic slowdown or recession, you can expect these types of ETFs to sell-off. Here is an example as shown in SHYG:

High yield ETFs SHYG chart

In the event of a recession, we would rather have exposure to SHYG instead of SJNK. That’s because SHYG has a shorter average weighted maturity (2.15 years vs 3.38 years). That shorter maturity should make those bonds less vulnerable to default in a recession than SJNK. Think of it in terms of your own bills during a personal tight spot financially. You may have enough in savings to pay your bills over the short-term. It’s the longer-term that stresses you out most. In this case, SJNK has greater longer-term credit risk than SHYG. And that’s something we’d like to avoid.

Avoid the crowded trade

Some may argue why even invest in high yield at all if a recession is on the way? And that’s a valid point. But what if a recession isn’t on the way? What if all of the money that has flowed into government debt flows back out? In August, investors sold off high yield funds aggressively. HYG, a popular high yield ETF, saw the 4th most outflows of all ETFs according to ETF.com:

High yield ETFs top list of investor outflows

From a contrarian perspective, we like knowing we are buying while others are selling. This helps us avoid crowded trades and keeps us off the same side of the boat as everyone else. More importantly, high yield ETFs like SHYG help us fulfill our goal of generating predictable interest payments each month. Should recession fears come back into the market, we would expect ETFs like SHYG to move lower. However, with a 5.47% yield we have some cushion built into a price decline. SHYG needs to decline 5.47% on the year before our total return is negative. To us, that’s a better proposition than a negative yielding bond whose price must rise in order for the total return to be positive.

Tactically speaking, SHYG makes up only a small portion of our fixed income exposure in a given portfolio. We’re generally dedicating no more than 2-5% of a portfolio’s allocation to short-term high yield ETFs. And we usually pair that exposure with safer securities like short-term investment grade debt (SPSB) or short-term treasuries (SCHO). But if you are looking for yield, ETFs like SHYG are a good place to start.

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