These asset classes have been pilloried for luring in yield-seeking investors, only to have the rug pulled out from under them as credit conditions deteriorated. Hopefully an important lesson has been learned – the higher the yield, the higher the risk of capital invested.
Those that were burned the worst may be taking the tact of avoiding these sectors altogether. However, monitoring exchange-traded funds that track high yield indexes can be a useful endeavor. They can often provide insight into underlying stock market or debt dynamics as well as serve up trading opportunities showing relative value characteristics.
Let’s delve into some of the most important high yield ETFs that should be on your radar.
iShares iBoxx High Yield Corporate Bond ETF (HYG)
HYG is the largest high yield bond ETF with $16.7 billion in total assets. This passively managed index fund owns nearly 1,000 corporate bonds of companies with below-investment grade credit ratings. These types of fixed-income instruments are often referred to as “junk bonds” because of their lower quality credit fundamentals.
Investors who own a basket of junk bonds like HYG are nominally compensated for the higher risk by receiving a much higher yield than Treasuries or investment-grade corporate bonds. HYG currently has a 30-day SEC yield of 6.96% and income is paid monthly to shareholders.
A peek at the chart below shows how HYG broke below its 200-day moving average nearly nine months ago and has been in a persistent down-trend ever since. This ETF was down over 20% from high to low, but managed to claw its way back from the abyss during the February and March rally in risk assets.
The important question now is whether HYG is consolidating for another push higher or is it getting ready to rollover once again?
The most bullish scenario would be a tight range of consolidation followed by a confirmed breakout to new recovery highs above the downward sloping 200-day moving average. This would likely need to coincide with further strength in broad stock market indices such as the SPDR S&P 500 ETF (SPY).
If we start to see SPY and other stock market bellwethers roll over again, then it could easily lead to a retest of the February lows for HYG. Many investors believe in the adage that “credit leads equities”. As a result, these two asset classes will likely experience a similar fate through the remainder of 2016.
Alerian MLP ETF (AMLP)
Another well-known proxy of income and credit risk that is closely tied to the commodity markets are master limited partnerships (MLPs). AMLP tracks an index of the 25 largest and most liquid MLPs. These companies provide infrastructure, storage, and pipeline use for large oil and gas companies in the energy sector.
The unique tax structure of MLPs allows them to pass on a large percentage of their profits to shareholders in the form of dividends. Thus, these stocks are often prized for their above-average yields. AMLP sports a yield of 11.28% based on its most recent quarterly dividend and current share price.
This ETF has experienced a decline similar to junk-bond related indexes, which has been exacerbated by the downtrend in oil and natural gas prices. Similar to oil, this fund is off its lows for the year, but has been unable to regain positive territory for 2016.
I believe that this index will continue to demonstrate a high correlation with the energy markets over the next several years. Another factor to the MLP story will be credit conditions (Note: HYG), as many of these companies rely heavily on access to debt markets and other funding sources.
Keep these factors in mind if you are considering investing in this ETF. It may be a long road ahead to regain sustainable momentum and volatility will likely be a key risk.
iShares Mortgage Real Estate Capped ETF (REM)
If you are aggressive enough to seek out funds offering a double digit yield, then you have likely heard of REM. This ETF tracks an index of 38 mortgage REITs in the residential and commercial lending sectors. Mortgage REITs are characterized by their lofty dividends as a result of embedded leverage and low borrowing costs.
REM is a very focused strategy that is arranged in a market-cap weighted methodology. As a result, the top holdings make up a significant portion of the underlying asset base. This includes significant exposure to Annaly Capital Management (NLY) and American Capital Agency REIT (AGNC).
REM currently has a 30-day SEC yield of 12.30% and income is paid quarterly to shareholders. It’s easy to see how investors can be lured into mortgage REITs by the tremendous yields. However, the volatility and risk that is associated with maintaining that dividend is often overshadowed.
This ETF has also traced a path similar to high yield bonds over the last 12 months and has just recently experienced a sharp rebound.
Future price action in this ETF is likely going to be governed by a combination of factors including real estate fundamentals, credit trends, and overall appetite for risk in aggressive income assets.
Keep in mind that ETFs with high sensitivity to credit risk are best purchased during periods of duress in order to capitalize on their relative value to high quality fixed-income. Furthermore, these tools will require heightened vigilance in order to take advantage of their volatile nature.
This article is brought to you courtesy of David Fabian.