In the past few quarters, the markets have witnessed
speculation about a number of events and their impact on the
markets as we head into 2013. ECB's policy in order to tame the
Euro zone crisis, Fed's implementation of QE3 and the impact of
the presidential election are all weighing on the markets as they
struggle to find their footing.
This global economic uncertainty coupled with a slowdown in
the domestic U.S. growth rate have for long led to a risk
aversion climate among investors and an expansionary monetary
policy by the Fed-both leading to a frustratingly low interest
rate scenario in the economy(read
Inside The Two ETFs Up More Than 140% YTD
).
On the other side of the ledger are the income-seeking
investors who have had to comply with ultra low yields for quite
some time now. While most of the high yielding sources from the
ETF space seems to be tapped out, there is one segment which has
been pretty much overlooked although it looks promising,
'crossover bonds' (read
3 Excellent ETFs with More than 4% Yield
).
The
SPDR BofA Merrill Lynch Crossover Corporate Bond ETF
(
XOVR
)
is one such fund that targets this corner of the U.S. bond
market. Bonds in this fund are basically fixed income securities
that are highly rated in the non-investment grade bond space or
they are lower rated in the investment grade bond space (see
Market Vectors Files for Innovative Bond ETF
).
Launched in June of 2012, XOVR has been able to amass just
about $13 million till date and does a daily volume of just
around 11,000 shares. This suggests that the product has been
highly ignored by the investors. However, below are three reasons
that one may want to consider giving this overlooked product a
chance in their portfolio:
1) Providing Parity in Risk-Return Tradeoff
Traditionally, high quality bond
ETFs
are associated with lower yields and low quality (Junk) ones with
higher yields. This is due to the default (counterparty) risk
premium that the investor takes before investing in the lower
rated (i.e. Junk) bond ETFs.
Investing in these two classes of ETFs require different types
of risk appetite and the risk-return tradeoff is demonstrated by
1) high yields- high probability of default and 2) low yields-low
probability of default.
However, the crossover bond ETF XOVR, provides parity in the
risk-return tradeoff and captures the shades of grey between
these two scenarios. Thus they provide the opportunity for 1)
higher current income -as opposed to investment grade bond ETFs
by taking on 2) relatively lesser default risk -as opposed to
non-investment grade bond ETFs (see
Forget China, Buy These Emerging Market ETFs
Instead
).
XOVR has a 30 day SEC Yield of 3.40% and a majority of its
assets are allocated to investment grade securities, i.e. 55.16%
of its total assets are
'Baa'
rated which is the lowest rating among investment grade
bonds.
2) Pricing Differentials During Bond Crossover can be
Advantageous
Among all fixed income securities, Crossover Bonds are the
most susceptible to being upgraded to investment grade or
downgraded to Junk due to their proximity to either rating.
However, the rating would depend on individual credit rating
agencies.
Nevertheless, when a bond is downgraded to junk from
investment grade by one agency, the implied yield rises and the
bond price falls. This indicates an entry point at low levels.
However, it might happen that another agency after a brief period
of time might upgrade their rating on the same bond which pushes
implied yield lower, resulting in capital appreciation (see
3 Actively Managed Bond ETFs for Stability and
Income
).
On the contrary, if a junk bond is upgraded to investment
grade by a rating agency, the price of the bond increases,
indicating a decent exit point. Now if another agency downgrades
it to junk again after a period of time, the capital loss can be
avoided.
3) Probability of Potentially Higher Yields at Lower
Expenses
As we have already discussed, the crossover bond ETF, XOVR,
provides the potential for high yields due to the nature of its
target securities. Furthermore it comes at a relatively lower
expense especially compared to other high yielding avenues from
the Junk Bond ETF space (read
HYEM: The Best Choice in Junk Bond ETFs?
).
XOVR charges just 30 basis points in fees and expenses
compared to a Morningstar category average of 0.51%. Compared to
this, JNK charges 40 basis points in annual fees and expenses,
whereas HYG charges an expense ratio of 50 basis points.
Other Features
XOVR tracks the BofA Merrill Lynch US Diversified Crossover
Corporate Index. The components in the index are mostly U.S.
Dollar denominated, thereby eliminating any currency risk. It
targets the intermediate end on the crossover bond yield curve
suggested by an average maturity of 7.90 years. Also it carries
moderate interest rate risk and has a weighted average duration
of 5.72 years (see more in the
Zacks ETF Center
).
Presently, it holds 158 securities in its portfolio and has a
30-Day SEC yield of 3.40%. XOVR has returned 4.35% since its
inception, as of 7
th
November 2012.
|
Data Point
|
XOVR
|
|
Returns (Since Inception)
|
4.35%
|
|
Average Duration
|
5.72 years
|
|
Average Maturity
|
7.90 Years
|
|
Assets Under Management
|
$13 million
|
|
Expense Ratio
|
0.30%
|
|
Average Credit Quality of the Index
|
BA1
|
|
Average Daily Volume
|
11,000
|
|
30 Day SEC Yield
|
3.40%
|
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ISHARS-IBX HYCB (HYG): ETF Research Reports
SPDR-BC HY BD (JNK): ETF Research Reports
SPDR-BAML CR CB (XOVR): ETF Research Reports
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