Reasons to Keep It Short With Junk Bond Exposure

With the Federal Reserve apparently eyeing a 2022 interest rate increase, fixed income investors are once again contending with curveballs from the U.S. central bank.

The lay of the bond land in 2021 is a vexing cocktail of low interest rates, depressed credit spreads, and the specter of a looming rate hike. In other words, duration risk is now very much part of the equation for bond investors, and that's problematic at a time when low yields are so prevalent. With all that in mind, it could be an ideal time for income-starved investors to consider short-term high-yield bond funds.

“Given their shorter durations, this subset of high-yield bond strategies typically does better than the broader category during interest-rate spikes. When rates rose over the first 10 months of 2018, the typical short-duration high-yield offering returned 2.0%, outpacing its broader category's median return of 0.4%. More recently, when rates spiked in the first quarter of 2021, short-duration offerings posted a typical return of 1.7%, 75 basis points better than the group norm,” says Morningstar analyst Sam Kulahan.

The average yield on a short-duration junk bond fund resides around 2.7%. While that's lower than what investors find on traditional high-yield corporate debt funds, 2.7% is excellent by today's yield standards, and it's a solid percentage when considering that duration risk is lower. Additionally, short-duration junk bond ETFs usually feature less credit risk than standard duration equivalents.

“Short-duration high-yield funds also typically take on less credit risk than traditional high-yield strategies,” notes Kulahan. “As of June 2021, the typical short-duration high-yield offering held 5 percentage points more in BB rated debt, which is the highest rating for junk-rated debt, than the high-yield category norm. The typical short-duration high-yield fund also held 15 percentage points less in debt rated B and below than the high-yield category median.”

Examples of short-duration high-yield corporate bond exchange traded funds include the iShares 0-5 Year High Yield Corp Bond ETF (NYSEArca: SHYG), the SPDR Bloomberg Barclays Short-Term High Yield Bond ETF (NYSEArca: SJNK), and the PIMCO 0-5 Year High Yield Corp Bond ETF (NYSEArca: HYS).

For more news, information, and strategy, visit the Retirement Income Channel.


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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