Don't Overlook Junk Bond ETFs to Help Meet Income Needs

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Fixed-income investors should consider incorporating a high-yield bond exchange traded fund to bolster yields and diversify a portfolio.

"Investing in the [Bloomberg Barclays US Corporate High Yield Total Return Index] may be an interesting option to consider for a long-term investor seeking to boost current income while gaining a strategic exposure to an asset class that better diversifies a portfolio of equities and lower-yielding bonds," Eric Legunn, an ETF Strategist for Deutsche Asset Management, said in a note. "Investors concerned with a future downturn should be relieved to observe how well and how rapidly the High-Yield Index rebounded after the financial crisis (though past performance is no guarantee of future results)."

Over the short-term, Legunn argued that roll-down return, carry and price return due to changes in rates and spreads will affect bond returns. Currently, roll-down return is positive in today's upward-sloping yield curve environment. The approximate carry or yield-to-worst as a proxy on the High-Yield Index is about 5.6%. Lastly, price return is affected by duration, and with a 3.8 year duration, the High-Yield Index could decrease by 3.8% if rates rise by 1% or vice versa.

Deutsche Asset Management projects a -1.8% index return due to the negative effects of rising rates on bond prices, but investors could potentially expect to a total return of about 3.8% over the short run after factoring in yields of 5.6%.

"Therefore, in today’s low rate environment, high-yield bonds may still be attractive for yield-seeking investors," Legunn said.

Over the long-haul, investors are more interested in risk-adjusted return as price fluctuations due to volatility in spreads and rates are less important. Those who are concerned about lofty valuations and volatility may take comfort knowing that the High-Yield Index was resilient through the worst financial crisis in recent memory. Looking at the recent financial crisis, the maximum default rate on high-yield credit did not exceed 14% and high-yield bond indices declined by no more than 33% before recovering. Over this period, high-yield bonds managed the volatility better than equities, even recovering more quickly after nine months, compared to the 27 months needed for the S&P 500.

"In addition, in the years that followed the crisis, the High-Yield Index not only exhibited higher returns but also exhibited lower volatility than the S&P 500," Legunn said.

Investors who are interested in gaining exposure to high-yield debt may consider a bond ETF option like the Deutsche X-trackers USD High Yield Corporate Bond ETF (NYSEArca: HYLB ) , which tries to reflect the performance of the Solactive USD High Yield Corporates Total Market Index. HYLB has a 0.25% expense ratio, a 5.35% yield to worst and an average 5.68 year duration.

"ETFs mitigate idiosyncratic (i.e. issuer-specific) risk by providing investors with low-cost exposure to well-diversified baskets of high-yield bonds," Legunn said.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article was provided by our partner Tom Lydon of

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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