It goes through phases. At one point, the hot commodity were those leveraged ETF’s that gave extreme volatility and amazing performances in trending markets. Then, other products such as bond ETF‘s took off, for good reason. These days, with a lot of investors nervous following the big 2008 shock, income products such as covered call etf’s, dividend etf’s and preferred shares ETF have all been very big with investors.
High Yield Bonds Take Off In The Form Of ETF’s
Buying high yield bonds is an tremely difficult transaction. They are usually very illiquid, the pricing is very difficult to determine and you usually need to buy a few million dollars of bonds per transaction. Not exactly the best product for retail. For that reason, launching high yield bond ETF’s seemed like a great idea. Why? I sometimes feel like investors buying such ETF’s are only looking at the dividend yield (which results from the high interest payments that the underlying bonds pay out).
It’s Not Free Money
I think it’s important to always remember that no financial product is “perfect”. A bond or bond ETF that is able to pay out 2%, or sometimes a lot more than a traditional bond ETF has some downside that the other does not have. In this case, it’s the risk of default. The reason these companies are willing to pay such high interest payments is because they can’t get better rates elsewhere. That means that to an extent, they are distressed. If the economy starts to suffer again or that different things occur, a few of these bonds could default.
Don’t Forget The 2008 Lessons
Subprime loans were being bought by investors who figured that buying a large pool of loans was not very risky. At most, only a few of them would go bad. In fact, it turns out that on many of these products, a large portion of those loans did go bad. The same could certainly happen to high yield bonds. I don’t think that any product should be considered based off its yield alone.
That Being Said
I do still think that high yield bond ETF’s are good products and while they might be a bit overbought, they can represent a portion of many ETF portfolios. Here are a few examples that you can look into:
HYG-iShares iBoxx $ High Yield Corporate Bond Fund
JNK -SPDR Barclays Capital High Yield Bond ETF
PHB-PowerShares High Yield Corporate Bond Portfolio