The fixed income market remains one of the most challenging places to invest. As I write this, you can not find so much as a 2% yield anywhere on the standard U.S. Treasury yield curve. Investment-grade corporate bonds could net you around 3% if you're willing to go after long-term maturities. Junk bonds have been the landing spot for many income seekers in 2021. Their 4-5% yields, depending on the ETF, haven't kept up with inflation rates, but at least they've gotten investors closer to the breakeven point in terms of real yields. They've also produced around 4% total returns, whereas investment-grade corporates have been flat and Treasuries have been slightly negative.
2022, however, could be the year where risk is not rewarded. The Fed finally deciding to lift interest rates could put downward pressure on fixed income prices. Plus, the uncertainty surrounding the omicron variant - it may not be deadly as the other strains of COVID, but that might not matter economically if workers are forced to stay home or businesses are reducing hours due to staff shortages - could stifle GDP growth and pull risk asset prices lower.
Note: Interested in getting periodic e-mail notifications when articles are published here? Drop your e-mail in the box below!
A couple areas of the high yield bond market have been particularly interesting. The fallen angel bond group - those that were rated investment-grade when they were issued, but later downgraded to junk - have been outperformers. The markets were generally kinder to higher risk assets, but the potential for lower-grade bonds possibly returning to their former glory added a degree of attractiveness for investors.
The muni bond market was another area that did well. As a whole, the group has produced only minor gains in the area of 1-2%, but that's been enough to outperform other areas of the bond market. Munis, of course, are more beneficial to those in higher tax brackets, but taxable-equivalent yields are such that those in more modest tax brackets may still benefit as well. This is especially true in the high yield segment of the muni bond space, where taxable-equivalent yields could push near 5%.
Default rates on junk bonds, in general, are low, but this group can still be volatile. Adding exposure to junk bonds in most portfolios makes sense, but it'll be important not to overdo it in an effort to reach out for additional yield.
Ranking The High Yield Bond ETFs
The variety of ETF choices makes distinguishing the best from the rest a little challenging. You've probably heard most financial pundits talk about focusing on funds with low expense ratios. That can certainly be a big factor in deciding which ETF to go with (it's probably the most important factor, in my view), but there are a lot of things that could go into making the right choice.
That's where I'm going to try to make things easier for you. Using a methodology that I've developed, which takes into account many of the factors that should be considered and weighting them according to their perceived level of importance, we can rank the universe of available ETFs in order to help identify the best of the best for your portfolio.
Now, this certainly won't be a perfect ranking. The data, of course, will be objective, but judging what's more important is very subjective. I'm simply going off of my years of experience in the ETF space in helping investors craft smart, cost-efficient portfolios.
Methodology And Factors For Ranking ETFs
Before we dive in, let's establish a few ground rules.
First, all of the data is used is coming from ETF Action. They have gone through the ETF universe to identify and categorize those ETFs used here. There are many that qualify and we'll be using their categorization as a starting point. Many thanks to them for opening up their vast database for my use.
Second, let's run down the factors I used in the ranking methodology.
- Expense Ratio - This is perhaps the most important factor since it's the one thing investors can control. If you choose a fund that charges 0.1% annually over a fund that charges 1%, you're automatically coming out ahead by 0.9% annually. You can't control what a fund returns, but you can control what you pay for the portfolio. Lower expense ratios equal more money in your pocket.
- Spreads - This relates to how cheaply you can buy and sell shares. Generally speaking, the larger the fund, the lower the spreads. Bigger funds usually have many buyers and sellers. Therefore, it's easier to find shares to transact and that makes them cheaper to trade. On the other hand, small funds tend to trade fewer shares and investors often need to pay a premium to buy and sell. Considering expense ratios and spreads together usually give you a better idea of the total cost of ownership.
- Diversification - Generally speaking, the broader a portfolio is, the better chance it has at reducing overall risk. A fund, such as the Energy Select Sector SPDR ETF (XLE), provides a good example. 45% of the fund's total assets go to just two stocks - ExxonMobil and Chevron. By buying XLE, you're putting a lot of faith in just those two companies. An equal-weighted fund, such as the Invesco S&P 500 Equal Weight Energy ETF (RYE), would score higher on diversification than XLE.
- FactSet ETF Scores - FactSet calculates its own proprietary ETF ranking for efficiency, tradeability and fit. They basically are designed to tell us if an ETF is doing what it sets out to do. I'm not going to copy and paste that work that they're doing, but there is some influence there to make sure my rankings are on the right path.
There are a few other minor factors thrown into the mix, but these are the main factors considered.
One thing that is not considered is historical returns. Most ETFs are passively-managed and are simply trying to track an index, not outperform. ETFs shouldn't be penalized for low returns simply because the index they're tracking is out of favor at the moment.
I'm ranking ETFs based on more basic structural factors. Are they cheap to own? Are they liquid? Do they minimize trading costs? Do they maintain risk-reducing diversification benefits?
Being in the bottom half of the list doesn't automatically make a fund "bad". It simply means that due to a low asset base, a high expense ratio, a concentrated portfolio or some other factor, it poses additional costs or downside risks.
Top High Yield Bond ETF Rankings For 2022
The two cheapest high yield bond ETFs are in a clear tier of their own in terms of costs and grab the top two spots in these rankings. One name you won't find anywhere on this list is Vanguard. Why? Despite offering more than 80 ETFs in total, it doesn't offer a pure high yield bond fund.
The #1 spot goes to the iShares Broad USD High Yield Corporate Bond ETF (USHY). It is the 4th largest junk bond ETF and 2nd cheapest at just 0.15%. The cheapest is the #2 rated fund, the SPDR Portfolio High Yield Bond ETF (SPHY). This fund is a bit of a curiosity given that most funds that carry the SPDR name, charge just 0.10% and have been around for nearly a decade would likely be huge. SPHY, however, has just over $500 million in assets. It's gone through a few iterations over the years in terms of changing indexes, but SPHY is a true under-the-radar fund that shouldn't be ignored.
The two giants of this group - the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Bloomberg High Yield Bond ETF (JNK) - land at #5 and #3, respectively. The pair account for roughly 30% of all junk bond ETF assets. Between them is the JPMorgan High Yield Research Enhanced ETF (JPHY). It's easily the highest ranked actively-managed ETF on this list and uses a proprietary credit research methodology as well as an ESG overlay to build its portfolio, but its expense ratio of 0.24% is still one of the cheapest.
I mentioned fallen angel bond ETFs earlier. The iShares Fallen Angels USD Bond ETF (FALN) and the VanEck Fallen Angel High Yield Bond ETF (ANGL) are the two primary options for targeting this strategy. They come in at #12 and #20 overall. The SPDR Blackstone Senior Loan ETF (SRLN) is the 3rd largest junk bond ETF targeting the highly risky senior loan space, but it only comes in at #15 due to its high expense ratio. The Invesco Senior Loan ETF (BKLN) is a slightly cheaper but lower ranking alternative.
The next batch of 30 names contains mostly smaller ETFs, but there are some interesting non-traditional strategies to be found.
I've always found the Xtrackers High Beta High Yield Bond ETF (HYUP) and the Xtrackers Low Beta High Yield Bond ETF (HYDW) to be interesting options. HYDW has drawn significantly more interest than HYUP and offers investors another way to tilt their junk bond exposure.
The iShares BB Rated Corporate Bond ETF (HYBB) is another lower risk option for high yield exposure and targets the highest rated debt within this group, as the name suggests. The iShares Interest Rate Hedged High Yield Bond ETF (HYGH) and the WisdomTree Interest Rate Hedged High Yield Bond ETF (HYZD) remove most interest rate risk from the equation (although credit risk still exists).
The KraneShares Asia Pacific High Income Bond ETF (KHYB) is the biggest outlier of the group by far. Its high exposure to the Chinese real estate sector has made it something of a proxy for the problems happening over in Asia. It has a current yield of nearly 8%, but the unknown outcome of a potential Chinese real estate crisis makes this a particularly risky junk bond ETF to own.
And the rest of the high yield bond ETF rankings: