A Different ETF Avenue To Junk Bond ETFs

The conversation about high-yield corporate bond exchange traded funds, one that has perked up this year amid alleged liquidity issues and the specter of rising interest rates, is usually dominated by the iShares iBoxx $ High Yield Corporate Bond ETF HYG and the SPDR Barclays High Yield Bond ETF JNK.

Combined, HYG and JNK have over $26.3 billion in assets under management, making the duo the two largest junk bond ETFs. It almost seems as though other high-yield bond ETFs are overlooked, though there are some fine options away from HYG and JNK, including some hailing from those fund families. 

One of those “other” junk bonds meriting of consideration is the PowerShares Fundamental High Yield Corporate Bond Portfolio PHB. For much of this year, advisors and investors have heard about the astronomical growth of strategic beta ETFs and when more bond funds will embrace such a methodology. Well, consider PHB the forefather of smart beta bond ETFs because the fund tracks the fundamentally-weighted RAFI Bonds US High Yield 1-10 Index.

PHB's underlying index “invests in only credits rated B3 and above by Moody’s and B- and above by S&P. That means investors are exposed to the higher-quality segment of the high yield market. These are bonds viewed as having less default risk that have the potential to outperform during periods of volatility and widening credit spreads – the very conditions we’ve witnessed in recent months. (Of course, there are other times when lower-rated credits will outperform.),” said PowerShares in a recent research note. 

PHB's effective duration is 4.26 years, slightly higher than the comparable metric on HYG. The PowerShares ETF's modified duration is 3.99 years, which is slightly lower than modified duration on JNK. PHB's 30-day SEC yield of 4.95 percent is about 140 basis points lower than JNK's, but PHB has some perks.

Notably, PHB has no exposure to CCC-rated bonds, an area in which many junk-rated energy issuers dwell. As seasoned high-yield corporate bond investors, energy issuers have been a drag on the junk bond market for over a year. 

“Commodity and basic materials issuers were a major driver of high yield underperformance during the first three quarters. West Texas Intermediate crude oil prices plunged 24% in the third quarter alone to $46 per barrel, while the S&P 500 Materials Index fell nearly 18% in the third quarter. This is significant, as energy and materials issuers are major components of the high yield market,” according to PowerShares.

Over the past three years, PHB has returned 7.8 percent with volatility of 4.9 percent, an average of 60 basis points less than the volatility seen on HYG and JNK over the same period.