Under The Hood: Foreign Junk

This much is clear: Investors love bond ETFs. Of the 15 largest U.S.-listed ETFs by assets under management at the end of June, five were bond funds. Two of this year's most successful new ETFs are bond funds, those being the PIMCO Total Return ETF BOND and the WisdomTree Emerging Markets Corporate Bond ETF EMCB. Beyond BOND and EMCB, there are some new, obscure bond ETFs that do merit consideration by investors. One such example is the Market Vectors International High Yield Bond ETF IHY. The Market Vectors International High Yield Bond ETF debuted in April as the first of three high-yield bond funds introduced by Market Vectors this year. In six months of trading, IHY has raked in $20 million in assets under management, a decent start but perhaps not enough to make large crowds take notice. Average daily volume of almost 10,000 shares is also decent by the standards of a new ETF, but not jaw-dropping. Like any ETF, IHY has its pluses and minuses. One black mark against IHY is potential currency risk because the fund's holdings are not entirely denominated in U.S. dollars. In addition to greenbacks, IHY's holdings are denominated in euros, Canadian dollars and British pounds. On the other hand, investors that crave the robust yields offered by junk bonds might be missing out on international opportunities by opting to solely focus on ETFs such as the iShares iBoxx $ High Yield Corporate Bond ETF HYG and the SPDR Barclays Capital High Yield Bond ETF JNK. IHY's 30-day SEC yield is 6.59 percent. That tops JNK's 30-day SEC yield by almost 50 basis points and HYG's by almost almost 75 basis points. Grabbing that extra yield does come with a slight increase in duration as the ETF's average modified duration is 4.65 years. JNK's modified adjusted duration is just under 4.3 years while HYG's effective duration is less than four years. Additionally, IHY's holdings featuring an average years to maturity of 8.1 years, well above the average maturities in HYG and JNK. Clearly, there are pros and cons to IHY, but something else is clear about this ETF and that is the international high-yield bond market is a niche that is experiencing exponential growth. The international segment of the global high-yield corporate bond market has grown from approximately 10 percent in 1997 to 35 percent in 2011, according to Market Vectors. Should the prediction that bond ETFs will hold $2 trillion in AUM by 2022 prove accurate, it might be reasonable to expect narrowly focused products such IHY will capture enough investor capital to survive and thrive. There is reason to believe that can happen, particularly is risk appetite increases because international high-yield debt sports a low correlation to U.S. Treasuries or investment-grade corporates. "Global high-yield corporate bonds have had low or negative correlation to other bond asset classes. In fact, they have historically been more correlated to equities which may provide an opportunity to diversify bond portfolios," Market Vectors said in a research piece. IHY also offers potential for investors that merely care about performance. In the past 90 days, the new ETF has trounced the returns offered by BOND, JNK and HYG. For more on bond ETFs, click here.