Warming Up To Junk Bond ETFs In 2017

The Federal Reserve's plans for interest rates will remain front and center for fixed income investors this year, but that does not mean high-yield corporate bond exchange-traded funds should be ignored by income investors.

Even as global corporate defaults surged last year, investors poured into popular junk bond ETFs, including the iShares iBoxx $ High Yield Corporate Bond ETF HYG and the SPDR Bloomberg Barclays High Yield Bond ETF JNK. HYG and JNK are the two largest U.S. junk bond ETFs by assets.

Digging For Gems In Junk

While many investors believe junk bonds are a corner of the market where active management thrives, data support the idea that passive products like HYG and JNK are superior bets. For the three years ending last year, just 20 percent of active high-yield bond funds beat their benchmarks while that number drops to 11 percent over the trailing five years, according to CFRA Research.

High fees put active junk bond funds at a disadvantage relative to their passive rivals.

“The 1.1 percent average net expense ratio for funds in Lipper’s high yield mutual fund peer group limits the investment style from keeping up. High fees might have been less concerning in a strong 2016 — the average fund climbed 13.3 percent. But if returns are more similar to the mid-single-digit gains that were achieved in 2013 and 2014 or losses achieved in 2015, performance of expensive funds will be dragged lower,” said CFRA in a note out Monday.

The Bottom Line

HYG and JNK charge 0.49 percent and 0.4 percent, respectively, per year. Even the PowerShares Fundamental High Yield Corporate Bond Portfolio PHB, a smart beta spin on junk bonds, is cheaper than active equivalent. PHB charges half a percent per year.

The $1.27 billion PHB follows the RAFI  Bonds US High Yield 1-10 Index and has an effective duration of 3.7 years. HYG's duration is almost 3.9 years while JNK's modified adjusted duration is nearly 4.1 years. Duration is a measure of a bond's sensitivity to changes in interest rates.

CFRA Research has Overweight ratings on HYG, JNK and PHB.