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High-Yield Bond ETFs That Limit Losses

When rates fall, bond prices tend to rise. That would hurt the value of the short positions held by the hedged fund. In a period of flat rates, the short positions would not provide any capital gains or losses. But selling short imposes costs because of brokerage commissions and other expenses. Those costs, which can range from less than 0.10% to 1%, are subtracted from total returns.

Although the ProShares and Market Vectors funds track benchmarks and always sell short, First Trust High Yield Long/Short has some room to maneuver because it is actively managed. First Trust portfolio manager William Housey currently has 25% of his assets in short Treasury positions. But if conditions warrant, he is free to reduce the short positions or remove them altogether.

Housey favors companies with relatively steady cash flows. Worried about erratic markets, he has been underweighting the lowest-quality bonds, which are rated CCC. "We have ended up with a little higher credit quality than you see in some of the passive funds," he says.

Worried that rates will continue rising, Housey has put 15% of his portfolio in floating-rate senior loans. The loans are made to companies that are rated below-investment grade. When rates climb, the interest payments on the loans adjust upwards. Because of their adjustable rates, the loans have proved resilient this year. "The loans have been the best-performing fixed-income class lately," says Housey.

Although Housey has been shorting Treasury bonds, he has not been shorting high-yield bonds. He says that he only shorts high-yield bonds during periods when defaults are rising. At the moment, default rates are low, and corporate balance sheets are solid. "Cash flows are relatively steady, and businesses are performing quite well," he says.

At the time of publication, Luxenberg had no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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