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First Trust Rolls Out Long/Short Junk Bond ETF

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First Trust Advisors has added a new menu item for investors starving for dividend income in an era of unpalatable interest rates.

The Wheaton, Ill.-based firm rolled out last weekFirst Trust High Yield Long/Short ETF ( HYLS ), an actively managed ETF that seeks to generate income from investing in high-yield corporate bonds, aka junk bonds, while selling short U.S. Treasury and corporate bonds in hopes of profiting from falling bond prices.

This ETF is best suited for investors who are betting on rising interest rates. That's because when interest rates rise, bond prices will drop and eat away principal. Yields and prices move in opposite directions.

"The short Treasury positions allow the portfolio managers to isolate a portion of the interest-rate risk from the credit risk inherent in high-yield securities," First Trust said in a statement.

The fund's managers believe high-yield bonds offer less risk as the economy recovers because companies are able to generate ample cash flow, and default rates among junk bond issuers has been rather low. The managers may also short sell junk bonds if they anticipate an increase in corporate defaults.

HYLS charges a rather high annual expense ratio of 1.19%. Rick Ferri, founder of Portfolio Solutions with $1.1 billion in assets under management in Troy, Mich., says investors could apply the same strategy at a much lower cost by buying a high-yield bond ETF and selling short a Treasury bond ETF. For example you buy longSPDR Barclays High Yield Bond ( JNK ), which carries a 0.4% expense ratio and currently yields 6.72%, and short sell iShares Barclays 20+ Year Treasury Bond ( TLT ), with a 0.15% expense ratio.

In accounts that don't allow short selling, the short position could be taken with an inverse bond ETF such as ProShares Short 20+ Year Treasury ( TBF ), with a 0.95% expense ratio. Those with high liquidity also have tighter bid/ask spreads than a newly launched, thinly traded fund.

The major risk of investing in a long/short strategy is that both sides of the trade can go against you. If the economy slumps, inflation declines and investors pile into risk-free Treasurys, the fund will "get squeezed on the short side," says Neil Leeson, ETF strategist at Ned Davis Research in Venice, Fla. If rates stay the same, there's no need to hedge the long position in high-yield bonds, he adds.

In Rich Winer's experience, long/short funds tend to perform poorly long term. The president of Winer Wealth Management in Woodland Hills, Calif., says such strategies may reduce volatility, but they also reduce returns. He also believes fears of a sudden spike in interest rates are overblown as the Federal Reserve is expected to keep t rates low for another year if not longer.

"The economic recovery will continue to be slow and steady, and not provide any reason for the Fed to stop buying bonds or raise interest rates," Winer said in an email. "Also, central banks around the world are keeping rates low and implementing stimulus programs."

New ALPS High Volatility ETF

ALPS Advisors last Thursday launched U.S. Equity High Volatility Put Write Index Fund ( HVPW ). Tracking the NYSE Arca U.S. Equity High Volatility Put Write Index, the ETF buys stocks that trade in wide price ranges and sells put options in hopes of generating income.

Put options are contracts that give the buyer the right, but not the obligation, to sell a stock at a given price on a given date. The put seller has to sell the stock if it hits the strike price.

A put option provides insurance or a hedge against falling stock prices because it rises in value if the stock price drops. Conversely, if the stock price goes up, the put will lose value or expire worthless. The put seller profits if the stock price goes up or stays the same.

The ETF aims to pay out 1.5% of fund assets every two months as investment income or a short-term capital gain. But it's not guaranteed and could be less if the ETF doesn't earn enough to cover the payout.

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

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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