The Federal Reserve lowered interest rates last week and the door is open for another rate cut later this year, prompting many income-starved investors to revisit fixed income segments beyond government debt. Some are likely to consider the high-yield corporate debt. For those looking to skirt volatility in that asset class, the IQ S&P High Yield Low Volatility Bond ETF (HYLV ) is an exchange traded fund to consider.
HYLV tracks the S&P U.S. High Yield Low Volatility Corporate Bond Index. That index “is designed to measure the performance of U.S. high yield corporate bonds with potentially low volatility. The index is comprised of bonds from the S&P U.S. High Yield Corporate Bond Index and is a modified market value weighted index with a 3% cap on any single issuer,” according to S&P Dow Jones.
Tumbling yields on safer government and corporate debt pushed investors toward riskier and higher yielding debt, like junk bonds. Furthermore, U.S. corporate bonds are enjoying a stronger tailwind in an environment of strong economic growth, healthy earnings and dropping default rates.
HYLV “attempts to improve risk-adjusted performance by targeting corporate bonds rated below-investment-grade with low risk relative to the junk universe,” said Morningstar. “It won’t always keep pace with the market, but it should offer better downside protection and better risk-adjusted performance than the broad high-yield bond market over the long term. That said, this is still a risky bond investment and not a suitable replacement for investment-grade bonds.”
Specifically, high-yield bonds, like their names suggest, provide opportunities for enhanced yields. Since 1994, the high yield bond market has exhibited an average spread of 509 basis points above Treasuries.
High-yield bonds have historically exhibited a lower sensitivity to interest rate changes. During periods of rising rates, high-yield assets have returned a mean 4.23%, compared to the -1.22% decline in investment-grade debt and -2.46% drawdown for U.S. Treasuries. Fortunately, rates are declining.
The bulk of HYLV’s holdings (more than 80%) are in the BB category, which can help in the objective of reducing volatility.
“As far as strategic-beta bond funds go, this is one of the more promising,”according to Morningstar. “It relies on forward-looking information to dial down risk while preserving diversification and taking steps to mitigate transaction costs. As an added benefit, its 0.40% expense ratio is among the lowest in the high-yield Morningstar Category and is slightly lower than HYG’s. This fund is worth keeping on your radar.”
