NEW YORK (TheStreet) -- Billionaire Carl Icahn has been warning investors to say out of the high-yield debt market because it is a bubble that could burst any time.
But before you run for the exits, consider an alternate way to invest in junk bonds that has somewhat less risk: exchange-traded funds that track the high-yield market.
The two biggest high-yield ETFs are the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) - Get iShares iBoxx $ High Yield Corporate Bond ETF Report and the SPDR Barclays High Yield Bond ETF (JNK) - Get SPDR Bloomberg Barclays High Yield Bond ETF Report. These two funds have nearly $24 billion in combined assets under management, indicating widespread adoption among institutional and retail investors.
Over the past three years, the ETFs have posted an average return of 14.7%, more than triple the performance of the iShares Core U.S. Aggregate Bond ETF (AGG) - Get iShares Core U.S. Aggregate Bond ETF Report, broad bond market fund. Year-to-date, the SPDR Barclays High Yield Bond ETF and iShares iBoxx $ High Yield Corporate Bond ETF are up 1.3% and 0.9%, respectively, while the iShares Core U.S. Aggregate Bond ETF is up just 0.1%
There are several advantages to bond ETFs. While bond pricing is often difficult to figure out, bond ETFs trade on an exchange and are priced just like stocks.
"That is a key distinction that ultimately needs to be hammered home," said Peter Tchir of Brean Capital. "The price of one specific bond is much more difficult to estimate with reasonable success than the average price of highly diversified pool of bonds, where you have much more immediate, real-time and often executable price information."
Bonds don't trade on an exchange, but like stocks, ETFs, including bond funds, do. That gives buyers and sellers of bond ETFs easy intraday access. Prior to the financial crisis, bond dealers could hold up to 3% of the market in which they transacted, but post-crisis regulations have lowered that number to 0.25% to 0.5%, according to Barclays. Fixed-income inventory restrictions have sent professional investors in search of additional liquidity, and in the high-yield corporate market, that search has included ETFs.
One of the biggest concerns facing fixed-income investors opting to use ETFs is how the funds behave during times of market stress. A hypothetical scenario where the Fed surprisingly raises interest rates could cause a raft of selling in funds such as the iShares iBoxx $ High Yield Corporate Bond ETF and the SPDR Barclays High Yield Bond ETF and could cause the funds to trade at significant discounts to net asset value (NAV).
When rates rise, the calamity that critics expect to ensue among junk bond ETFs may not come to pass, because holders of these products are sophisticated investors. That is good for the home-game investors who also own the likes of the iShares iBoxx $ High Yield Corporate Bond ETF and SPDR Barclays High Yield Bond ETF.
"The daily flows and the positioning indicates, at least to me, that these products have achieved a critical mass and are not some one-sided trade held only by neophytes who are just waiting for a mistake to be exposed," Tchir said. "Sophisticated investors trade these products for may reasons, which I think is a positive."
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the ETFs mentioned.