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Picking The Right Junk Bond ETF

From Seeking Alpha


Summary

  • Junk bond ETFs open the world of high-yield bond investing to ordinary investors in a way previously inaccessible.

  • Generally regarded as far more exposed to default risk, junk bonds feature higher yields, often greater volatility, and more substantial risk-reward than their investment-grade counterparts

  • There's only a few junk bond ETFs with enough assets and volume to be considered truly "investment grade" themselves, as many other ones face significant closure and liquidity risk.

  • These main junk ETFs differ in ways including average maturity/yield curve segment, country exposure, investment rating distribution, yield, expenses, holdings, and more.

  • Investing in high-yield securities is not necessarily negative to a portfolio but should be done with greater care due to the higher risk-reward proposition of the securities.

In the words of "Junk Bond King" Michael Milken:

"Junk bonds? Perhaps there's a better name for the bonds that fuel 95 percent of American business."


Investors like yield and junk bonds offer them. Described as bonds generally carrying a rating below BBB, they are considered not "investment grade" due to the risky financials of their issuers and thus non-negligible possibility of bond default. In past decades, they were largely inaccessible to the ordinary investor, but now with the advent of ETFs are available just a click away with ETFdb currently listing 43 US-traded junk bond ETFs.


The span of junk bond ETFs available vary significantly in their structure as well as the nature of the underlying bonds themselves. For example, the VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL) consists of bonds which, when originally issued, were investment-grade, but then as their backing companies' credit worthiness deteriorated, the price of the bonds, and thus yield on them, fell to junk-level status. Other junk bond ETFs differ in ways more similar to their non-junk bond counterparts, such as by average maturity date.


Junk bonds are risky - in the midst of the 2008 financial crisis as company defaults become not only a serious risk but material reality for many companies, the junk bond market rate soared up to over 23% (as compared to the current market rate of about 5.9%). With yield comes costs.


The market for "safe" junk bond ETFs is rather small. I believe that an ETF for a longer-term investment strategy, as compared to trading, and in such a narrow sector should have several characteristics that ensure its stability and liquidity. As a bar, we can say that this means at least $1 billion in ETF assets, reducing event horizon dangers as ETF funds dwindle, and liquidity of at least 500,000 shares a day.


By this measure, there are only five junk bond ETFs fitting that "safe" criteria where one can worry less about the structure of the ETF affecting one's investment strategy and rather focus on the characteristics of the fund composition itself.


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