Mutual Fund Commentary
QUENCHING THIRST FOR HIGH YIELD WITH LOWER DURATION
As long as the risk-on trade supported by central banks around the world keeps liquidity high and corporate fundamentals healthy, junk-bond yields will likely continue appealing to investors and, subsequently, attract buyers to high yielding, low quality corporate-bond exchange-traded funds (ETFs), says S&P Capital IQ fund research.
"To identify appealing high-yielding securities remains a top priority for many investors," notes Todd Rosenbluth, S&P Capital IQ's director of exchange-traded fund (ETF) and mutual fund research, who points to the more than $2 billion added to high-yield corporate exchange traded products in October 2013. However, Rosenbluth acknowledges some relatively new junk-bond funds may be better prepared to cushion investors' portfolios against rising rates, which drives bond prices lower.
"Investors can lose principal as an increase in interest rates would negatively affect the fund's price," he explains, adding that a bond's duration will determine how its price is affected by interest rate changes. For example, if rates move up by one percentage point, from say 3% to 4%, the price of a bond fund with an average duration of 5 years will move down by 5%, while a bond fund with an average duration of 10 years will move down by about 10%.
Investors may be shielded from that risk for the time being, as the big move up in rates is now not expected by the consensus until next year. S&P Capital IQ believes macroeconomic data along with the impact of the U.S. government shutdown has now pushed tapering expectations, once widely expected to have begun by now, out to March 2014. What's more, incoming Federal Reserve Chair Janet Yellen's recent dovish comments about the risks of premature tapering only served to cement investors' belief the coast was clear, according to S&P Capital IQ's Investment Policy Committee.
But because time is of the essence, S&P's Rosenbluth points to a relatively new ETF with shorter duration than peers. PowerShares Global Short Term High Yield Bond (PGHY 25 Underweight) has an average duration of 1.6 years, as of the most recent data provided to S&P Capital IQ, which calculates its average coupon at 7.2%. The ETF seeks to track the performance of the Deutsche Bank Global Short Maturity High Yield Bond Index, which follows performance of U.S. and foreign short-term, non-investment grade bonds denominated in U.S. dollars.
What is noteworthy about its underlying holdings is that European corporate-bond markets are outpacing those in the U.S., according to reports in the Wall Street Journal on November 21, attributing research to sell-side firms. European high-yield bonds are up 8.5%, compared with up 6.4% for U.S. high yield, according to Barclays.
Since its inception in June 2013, the PowerShares ETF has outperformed the traditional bond-fund benchmark, the Barclays U.S. Aggregate Index, by about 160 basis points. Regarding its yield, the ETF garners a neutral or marketweight assessment of its 30-day SEC yield, which was recently 3.8%. Meanwhile, by comparison, the yield on the 10-year Treasury bond, a widely used reference point for fixed-income investors, has declined to 2.75% as of November 26 from its early-September highs.
With sufficient data related to the underlying holdings, S&P Capital IQ has enough information to provide an assessment of the ETF's risk considerations and cost factors. Risks receive a favorable or overweight ranking due to favorable liquidity and duration inputs. However, costs are ranked "underweight" as the ETF's price-to- net asset value (NAV) per share of the underlying holdings is viewed negatively, while its 0.35% expense ratio and bid/ask spread of $0.13 are viewed as neutral inputs to the overall ranking.
Rosenbluth, who routinely compares ETFs that sound the same but are not the same, points to the SPDR Barclays Short Term High Yield Bond ETF (SJNK 31 Marketweight) and PIMCO's 0-5 Year High Yield Corporate Bond Index ETF (HYS 107 Marketweight) as slightly older, higher yielding peers with longer duration.
The SPDR ETF, which started trading in March of 2012, states its 30-day SEC yield is 3.9%, while its modified adjusted duration is 2.2 years, according to its web site displaying information as of November 22. The ETF's average coupon is calculated by S&P Capital IQ to be 7.5%.
PIMCO's ETF started trading in June of 2011 and reports a 30-day SEC yield of 3.3%. The ETF's average duration is calculated at 2.7 years and its average coupon, 6.7%, according to the most recent data supplied to S&P Capital IQ.
These two ETFs, which each have over $2 billion in assets, despite less than three years of history, offer investors just U.S. high yield exposure, while the PowerShares one offers more geographic diversification. While just over half of PGHY's assets are tied to U.S. bonds, the ETF has credit exposure to developed non-U.S. markets such as France and the United Kingdom and emerging markets such as Brazil and Russia. Reports on these ETFs can be found at the ETF tab of MarketScope Advisor.