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High-Yield ETF Performed Well Amid Turmoil

Roger Nusbaum

A reader question led me to realize that now might be a good time to revisit the issue, since the market situation has changed so much.

Investors can access high-yield bonds through traditional mutual funds, closed-end funds, this ETF and individual issues. Individual issues can be difficult for do-it-yourselfers because of issuer risk and liquidity risk, so that leaves a fund of some sort as the most likely choice.

The general thesis of the article was that HYG, because of the nature of ETFs, would be a less volatile way into the high-yield market than most closed-end funds.

Closed-end funds have a set amount of shares, so the market price can deviate from the net asset value. In times of extreme swings in market sentiment, closed-end bond funds can fall much more than people expect. ETFs can create or redeem shares based on demand, so the fund's market price stays much closer to the NAV.

There would be times where that extra volatility would be a good thing and times, like last September, where it would not be a good thing. I was concerned in that article about the economic cycle and the stock market cycle each ending which, if correct, would normally be a bad time to increase volatility. Typically, it would make sense to decrease volatility.

As the chart shows, HYG has held up better, and practically sat out the panic that occurred in mid-March, than the CEFs since that article was published. The result should not be interpreted as HYG being better, but more correctly, better-suited to the end of the cycle, which happened to coincide with an unusual dislocation in the interest rate market.

We would need to see how HYG does compared to the CEFs when the next bull market/economic expansion starts before being able to conclude that HYG is better for all seasons, and I would expect that in an economic upswing the potential volatility of the CEFs might be beneficial, and they could outperform at that time.

Click here for larger image.

The makeup of the fund is very similar to what it was last September. The yield has increased to 8.62% from 7.41%, but the payout should be expected to vary from month to month. The weighted average maturity is 6.9 years down slightly from 7.11 years. The average credit rating is still B-minus.

HYG has 50 holdings, most of which are about 2% each of the fund, and no issuer has more than one bond represented in the fund, so there is good insulation against default.

The fund is less volatile than some similar CEFs, but from peak to trough over a period of 10 months, it still dropped almost 15%.

The role that high yield -- and by extension, HYG -- plays in a portfolio is to the riskier portion of the fixed income allocation. For most folks, it probably doesn't make sense to exceed 10% of the fixed income side in high yield.

The 15% decline in a fund held at 10% would obviously work out to only a 1.5% drag on the entire portfolio, which seems reasonable.