Investors pulled money from high yield bond ETFs in the first quarter, but demand has been building since then, and to start the fourth quarter it has accelerated. Indeed, iShares iBoxx $ High Yield Corporate Bond ETF (HYG) had the largest day of inflows with more than $700 million to start the quarter. Nonetheless, the ETF was trading the next day at just a slight premium to its net asset value, confirming that unexpected trading volume is not necessarily a reason for concern.
Coupled with net inflows of $200 million for peer SPDR Bloomberg Barclays (JNK) and more limited flows into Xtrackers USD High Yield Corporate Bond (HYLB) and other short-term products, high yield ETFs pulled in more than $1 billion in the first two days this month. To put the recent demand in perspective, high yield corporate bonds gathered $2.4 billion in the third quarter, partially erasing the year-to-date outflows for the investment style. In contrast, investors consistently favored investment-grade corporate bond ETFs that provide greater capital preservation than their high-yield siblings.
For HYG, the 8.2 million shares traded on October 1 was 1.4 times its average daily volume. To CFRA this gives us confidence that liquidity remains strong and should support further investor interest. While we don’t yet know how much of the trading volume in HYG and its peers was in the secondary market, according to the Investment Company Institute, 79 percent of daily volume in the 3-year period ended December 2017 occurred in the secondary market. In other words, investors are trading mostly with one another without the need to create or redeem shares. Yet, investor concerns remain that flows into and out of high yield ETFs will be problematic in the broader bond market.
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Heather Brownlie, U.S. head of BlackRock’s Fixed Income iShares, explained exclusively to CFRA in a video that the bond ETF market is a tiny (less than 1.5 percent) fraction of the total U.S. debt market. Brownlie added that HYG was tested in 2008 through the financial crisis, and during 2015’s liquidity crisis when Third Avenue gated (did not immediately return shareholders their investment) a mutual fund, and she consistently sees investors looking to the ETF for price discovery and to access liquidity.
In the same video, responding to a common concern that index-based ETFs are loaded up on the most indebted companies, Brownlie explained to us that investors need to be careful to understand that more debt does not mean higher risk.
While the credit risks remain prevalent, the 61 global corporate defaults year-to-date tallied by S&P Global Ratings are lower than in recent years. According to CFRA Research, HYG, JNK and HYLB provided similar credit exposure, with approximately 47 percent of assets rated BB and 5 percent rated BBB.
CFRA thinks investors in these bond ETFs should be focused more on the credit risk than the interest-rate risk, but we highlight there are also lower duration alternatives for those wary of further interest rate hikes.
For example, SPDR Short-Term High Yield Corporate Bond (SJNK) has average duration of 2.2 years and still sports a compelling 5.8 percent yield. Peer iShares 0-5 Year High Yield Corporate Bond ETF (SHYG) has 2.3 years of duration and has a 5.6 percent yield.
In rating fixed income ETFs, CFRA combines this holdings-level analysis with fund attributes including the ETF’s liquidity, expense ratio and bid/ask spread. Reports can be found on MarketScope Advisor.
Todd Rosenbluth is the director of ETF and mutual fund research at CFRA. Learn more about CFRA’s ETF research here.
