This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
TheStreet Open House

The Hidden Risks of High-Yield ETFs

Stocks in this article: HYG JNK VWEHX

NEW YORK ( TheStreet) -- Searching for income, investors have poured into high-yield ETFs. Among the favorite choices are iShares iBoxx $ High Yield Corporate Bond (HYG) and SPDR Barclays Capital High Yield Bond (JNK), which both yield around 7%. Assets in the two funds total $25.3 billion, up from around $13 billion at the beginning of 2011, according to IndexUniverse.com.

But ETFs may not be the best way to hold high-yield bonds, which are rated below-investment grade. The problem is that junk bonds are not highly liquid. Many bonds rarely trade. During the downturn of 2008, markets froze, and it was difficult to trade bonds at all. As index trackers, ETFs must buy bonds -- even if portfolio managers must pay a big premium to complete transactions. Instead of buying index funds, investors should consider actively managed portfolios, says Samuel Lee, an ETF analyst for Morningstar. "Active managers have the discretion to avoid trading when prices are ridiculous," says Lee.


Partly because of their freedom to trade, many actively managed mutual funds have outdone ETFs in downturns. When investors worried about the outlook for the eurozone in May, high-yield bonds sank. For the month, the iShares iBoxx ETF dropped 3.2%, while the average actively managed high-yield mutual fund lost 1.5%, according to Morningstar. The active managers also excelled in September 2011 when they lost 3.3%, compared to a decline of 5.3% for the iShares fund. During the past three years, the average active fund returned 14.4% annually, while the iShares fund returned 14.1%.

Mutual funds can also have an advantage because the shares always sell for the value of the assets in the fund. In contrast, ETF share prices fluctuate. When many investors seek to buy, the ETF shares can sell for a premium to the value of the assets in the fund. During hard times, the shares can trade at a discount. Funds that hold highly liquid assets, such as the stocks of the S&P 500, rarely trade at big premiums or discounts. But the price of high-yield funds can vary. The SPDR high -yield ETF recently sold for a premium of 1.24%. So investors had to pay $101.24 to buy $100 worth of assets.

1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Jim Cramer and Stephanie Link reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

Jim Cramer's protégé, David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
Try it NOW
Try it NOW
Try it NOW

Check Out Our Best Services for Investors

Dividend Stock Advisor

Jim Cramer's protégé, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
Try it NOW
Try it NOW
Try it NOW
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!

Markets

DOW 17,164.95 -251.90 -1.45%
S&P 500 1,994.99 -26.26 -1.30%
NASDAQ 4,635.24 -48.1670 -1.03%

Partners Compare Online Brokers

Free Reports

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs