An ETF for High Yield Corporates

Focus: FUNDS

Carla Pasternak Image Carla Pasternak Editor, The Income Investor

Despite a bear market for bonds in the face of rising interest rates and inflation expectations, one corner of the fixed income market is thriving. High-yield corporate bonds returned a robust 23% this past year, on pace with the S&P 500, observes Dr. Carla Pasternak, editor of Dow Theory Letter's The Income Investor.

Popularly known as “junk bonds,” these sub-investment grade debt obligations are rated BB+ or below by Standard & Poor’s. They currently offer average yields of 6% in return for their higher risk of default than investment grade bonds.

What about rising interest rates? Typically, bonds lose value as interest rates rise. However, high-yield bonds are different. Their above-average yields and generally shorter maturities tend to make them less sensitive to the early stages of a gradual rate rise.

In fact, the initial round of rates hikes tends to be a positive for high yield bonds. Rising rates suggests the economy is strengthening, and that means lower default rates for corporate issuers.

High yield ETFs allow you to invest in the entire sector. While ETFs don’t provide return of principal, they do offer steady robust monthly dividend payments and potential capital gains as you rotate in and out of the sector.

With $19 billion assets under management, the iShares iBoxx $High Yield Corporate Bond ETF (HYG) is the largest ETF in the corporate high-yield category.

The fund’s benchmark index includes highly liquid,, dollar-denominated bonds. To ensure trading liquidity, there must be at least a $400 million issuance of these bonds and they must mature within 15 years.

About half the 1,000 bonds in the portfolio carry  a credit rating of  BB, just below investment grade.