The case for a high yield ETF

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May 11, 2021
 

Where do investors turn to for income? With global central banks utilizing all tools to keep rates suppressed and the mountain of debt trading at negative yields reaching US$18 trillion, as of the end of 2020, almost double that of 2019 ($10 trillion)1, that’s a key question. Given that backdrop, it is little wonder investors are looking outside the usual avenues for their returns.

The case for a high yield ETF

One option is the high yield bond market, specifically the US high yield bond market, which continues to grow. In 2019 US high yield bond issuance rose to $253.2bn with the asset class seeing capital inflows in almost every month of 2019, reversing the trend seen in 2018. 2 In 2020, this rose again to $428.3bn.2 By March 11, 2020, the volume was already at more than $100bn.3

High yield bonds typically offer higher coupons than investment grade corporate or sovereign bonds. Investors may also value the potential for diversification from equities or from their investment grade and sovereign peers. Third, the increase in issuance can create an improvement to underlying relative liquidity.

That’s not to say there are no downsides. It stands to reason that companies issuing high yield bonds have lower credit ratings than their investment grade peers and are generally considered to have a greater risk of default. Volatility can also be higher in the high yield space than with investment grade-rated corporate debt or higher-rated sovereign bonds.

For active managers the goal to match or exceed a US high yield index return has proved to be a challenge. Active managers face implementation hurdles such as higher trading costs, low liquidity, and difficulty in sourcing high yield bonds. At the same time, many investors do not opt for a straight passive approach in this market sector for similar reasons.

While an appealing part of the investment market, with an average yield to worst (lowest potential yield that can be received on a bond without the issuer actually defaulting) at 3.89%4, defaults – if not mitigated – can pose a risk in a passive strategy. The US high yield TTM5 default rate finished 2019 at 3.3%, its highest level in three years rose to close the year (as of December 10, 2020) at 5.2%, a level not seen since 2009.6

Are there ways to mitigate these risks? The evolution of the ETF market has seen some entrants strive to tackle the dilemma of high yield bonds, introducing options to help facilitate lower trading costs and add a measure of flexibility. Among these are the implementation of different trading options, such as a stratified sampling approach to help the investment team effectively manage turnover and transaction costs. Other tools may also be used to help mitigate some of the downside risks posed by the threat of defaults in the sector.

Combined, such trading techniques, and the ETF vehicle itself, are making an asset class that was once the purview of pure active managers, more accessible.

1 Bloomberg. World’s Negative-Yielding Debt Pile Hits $18 Trillion Record. December 11, 2020.

2 Debt Explorer. December 31, 2020.

3 Source Dealogic, accessed May 11, 2021. Actual figure for US High Yield issuance to March 11, 2021 is $113.5bn.

4 Bloomberg. Based on the Bloomberg Barclays US Corporate High Yield Total Return index. As at May 10, 2021.

5 A trailing twelve-month yield - the percentage of income the fund portfolio returned to investors over the past 12 months.

6 Fitch U.S. High Yield Default Insight (YTD Default Rate Surpasses 5%; Energy TTM Default Rate Tops 15%). Dec 10, 2020.

 

Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. To obtain a prospectus, or a summary prospectus, if available, that contains this and other information about a fund, contact your financial professional or visit im.bnymellon.com. Please read the prospectus carefully before investing.

ETF shares are listed on an exchange, and shares are generally purchased and sold in the secondary market at market price. At times, the market price may be at a premium or discount to the ETF's per share NAV.

In addition, ETFs are subject to the risk that an active trading market for an ETF's shares may not develop or be maintained. Buying or selling ETF shares on an exchange may require the payment of brokerage commissions.

ETFs trade like stocks, are subject to investment risk, including possible loss of principal. The risks of investing in the ETF typically reflect the risks associated with the types of instruments in which the ETF invests. Diversification cannot assure a profit or protect against loss.

Risk

Investors may not invest directly in any index.

Bonds are subject to interest rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines. High yield bonds involve increased credit and liquidity risk than higher rated bonds and are considered speculative in terms of the issuer’s ability to pay interest and repay principal on a timely basis.

Definitions

Options: Conditional derivative contracts that allow buyers of the contracts (option holders) to buy or sell a security at a chosen price. Stratified sampling approach: An indexing method where the ETF portfolio manager divides an index into different buckets, where each bucket represents different characteristics of the index.

Past performance is no guarantee of future results.

This material has been provided for informational purposes only and should not be construed as investment advice or a recommendation of any particular investment product, strategy, investment manager or account arrangement, and should not serve as a primary basis for investment decisions. Prospective investors should consult a legal, tax or financial professional in order to determine whether any investment product, strategy or service is appropriate for their particular circumstances. Views expressed are those of the author stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change. The information is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

BNY Mellon Investment Management is one of the world’s leading investment management organizations, encompassing BNY Mellon’s affiliated investment management firms and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the Corporation as a whole or its various subsidiaries generally. BNY Mellon ETF Investment Adviser, LLC is the investment adviser and BNY Mellon Securities Corporation is the distributor of the ETF funds, both are subsidiaries of BNY Mellon.

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