Renewed Interest In A Nifty Junk Bond ETF

It is often said that the smart beta phenomenon has not earnestly made its way to the world of fixed-income exchange-traded funds. While that is true to an extent, there are some smart beta bond ETFs that have lengthy track records.

Consider the PowerShares Fundamental High Yield Corporate Bond Portfolio PHB. Often overlooked in the junk bond ETF conversation, the PowerShares Fundamental High Yield Corporate Bond Portfolio is neither a new nor small ETF. The $1.1 billion PHB debuted about 10.5 years ago.

A Diamond In The Rough?

PHB tracks the RAFI Bonds US High Yield 1-10 Index which “is comprised of US dollar-denominated bonds that are registered with the SEC or that are Rule 144A securities that provide for registration rights and whose issuers are public companies listed on a major US stock exchange,” according to PowerShares, the fourth-largest U.S. ETF issuer.

While most bond ETFs, including high-yield funds, weight holdings by market value, the RAFI methodology tracked by PHB takes a different approach. That methodology has been applied to equity ETFs using four factors, including gross revenue, gross dividends and cash flow, according to Research Affiliates. Book value is the other factor used.

The Bond Element

Bonds in PHB's index must have $350 million outstanding and be rated BB+ or lower by Standard & Poor's.

“All issues must have a minimum of two-year call protection when entering the index. Poison puts and make-whole provisions are allowed. On entering the index the minimum tenor is six years for the 5-10 year maturity cell and two years for the 1-5 year maturity cell. An issue will be removed from the index at the last month end before maturity,” said Research Affiliates.

Home to 271 high-yield corporate bonds, PHB has an effective duration of 3.6 years and a yield to worst of 4.3 percent. The ETF has a 30-day SEC yield, which is lower than other junk bond ETFs, but PHB's duration is lower than its rivals and none of PHB's holdings dwell in the highly speculative “C” rating category.

Over 42 percent of PHB's holdings are issued by consumer discretionary or energy companies. Another 19.7 percent are courtesy of industrial and materials companies. Investors have added $43.6 million to PHB, the second-best total among all PowerShares ETFs during that period, according to issuer data.