Three Actively Managed Bond ETFs for Stability and Income (LQD, HYG, BND, ELD, HYLD, BOND)

Eric Dutram: ETFs as an investment avenue are often associated with passive fund management style which enables them to be more cost effective (in terms of expense ratios) than their mutual fund cousins. However, with the growth of the ETF industry as a whole, ETF managers are continuously striving for flexibility and new investors in order to capture more assets.

This paves the way for actively managed ETFs to take center stage, especially in a highly dynamic market environment. Having said this, it is prudent to note that there are a number of actively managed ETFs available in the market today.

However, this article highlights some of the positives of three such bond ETFs which investors could consider for stability as well income, especially in this ultra low interest rate environment.

So far this year investors have been fairly upbeat on the bond ETFs space. In fact some of the biggest names in this front like iShares iBoxx $ Investment Grade Corporate Bond (NYSEARCA:LQD), iShares iBoxx $ High Yield Corporate Bond (NYSEARCA:HYG) and Vanguard Total Bond Market (NYSEARCA:BND) have witnessed significant popularity this year in terms of asset accumulation.

There clearly has been a reversal in investor risk appetite in the third quarter as investors shifted focus from the traditional ‘low risk’ fixed income ETFs which was pretty much the way to go for investors in the second quarter, to ETFs tracking riskier asset classes. However, by no means does it imply that investor appetite has subsided in the bond ETF space (see Q3 ETF Asset Report: Investors Back in the Market?).

Yet this is by no means limited to the passive market, as the actively managed bond ETF space, many products have seen significant inflows in their asset base in fiscal 2012. In fact theWisdomTree Emerging Markets Local Debt ETF (NYSEARCA:ELD), Peritus High Yield ETF (NYSEARCA:HYLD) and PIMCO Total Return ETF (NYSEARCA:BOND) have witnessed positive inflows of around $200 million, $69 million and $2.67 billion respectively in their asset bases so far this year (source: Index Universe).

The WisdomTree Emerging Markets Local Debt ETF (ELD) seeks exposure in sovereign debt securities of emerging markets denominated in their local currency. ELD is exposed to a variety of emerging markets, however, it is fairly upbeat on Mexico (10.63%) and Brazil (10.50%).

Also, allocating a substantial portion of its assets in countries with stronger balance sheets such as Malaysia (10.27%) and Russia (7.00%) giving ELD a relatively low amount of worries on the currency front (read Buy These Emerging Asia ETFs to Beat China, India).

However, ELD will be subject to number of emerging market currencies in total, so the risk is by no means removed. Additionally, investors should note that the product has an effective portfolio duration of 4.73 years and an average maturity of 6.15 years, suggesting that it tracks the intermediate term of the yield curve and will be subject to moderate levels of interest rate risk.

The ETF goes beyond tracking an index and strives for steady income and capital appreciation. A one year look suggests that it has managed to deliver as it is up by 12.64% on a one year basis as of September 30th 2012.

Additionally the yield is quite solid as it has a distribution yield of 4.25%. Lastly, even though it is an actively managed ETF, it charges just 55 basis points in fees and expenses.

From the actively managed high yield ETF space we have the Peritus High Yield ETF (HYLD) which primarily aims at consistently high levels of cash flow streams in the form of interest income.

It invests in a variety of non-investment grade corporate debt securities by primarily employing a bottom up approach of securities selection. Some of the features of its highly active portfolio management are to select value creating securities and at the same time ensure minimum exposure to default risk.

It does this by eliminating risky leveraged buy outs (LBOs) based bonds which the company sees as not worth the headaches. Additionally, as a means of managing risk, it develops trigger points which exhibit a ‘position sell’ for individual securities in its portfolio when it violates a particular level, thereby managing losses.

Furthermore, as a hedge against negative market movements it can invest in U.S. Treasuries as and when the need arises (see Two Intriguing Financial ETFs with a REIT Focus).

Thanks to the active management employed by HYLD, it charges a hefty expense ratio of 1.36%. Nevertheless, the high costing seems justified when the one year return (as of 30th September 2012) of 15.48% is taken into account.

Moreover, thanks to the ultra low rate policy of the Fed, it is an appropriate choice for income starved investors as it pays out a solid distribution yield of 8.27%. However, it comes at the expense of credit quality. The product has amassed an asset base of $137.73 million and an average daily volume of about 31,000 shares.

The PIMCO Total Return ETF (BOND) is the ETF version of PIMCO’s flagship blockbuster mutual fund the PIMCO Total Return Institutional Fund (PTTRX). However, the $3.21 billion ETF has been outperforming its gigantic $169.32 billion mutual fund cousin since its inception in March of 2012.

The ETF has returned 9.93% since its inception while the mutual fund has returned 6.23% for the same time period. While having a much lower asset base certainly has allowed BOND to do well, one has to wonder if this outperformance can continue into the future.

Still, just to highlight the disparity between the two, BOND and PTTRX have a correlation of just 65% between the two since the launch of the ETF. Also, their one month rolling correlation has never increased 87% and has even gone to the extent of hitting a low of 30%, although there is admittedly a small sample size.

The ETF targets to maintain its weighted average duration in alignment with that of the Barclays Capital U.S. Aggregate Bond Index, with a maximum deviation of two years either way. The ETF measures the performance of investment grade debt securities which are issued by corporates, government and other institutions (see more in the Zacks ETF Center).

Interestingly, around 86% of the total assets of the ETF is allocated to Mr. Gross’ “Ring of fire” (i.e. countries with highest levels of fiscal deficit as a percentage of their GDP) countries. These are U.S 76%, France 1%, Japan 2%, Spain 3% and United Kingdom 4%(source (read Time to Consider Chinese Yuan ETFs?).

Nevertheless the ETF could be an appropriate core holding for investors seeking an exposure to total bond markets. It charges investors 55 basis points in fees and expenses and has been one of the highest asset accumulating ETFs this year.

On average, the product does about 477,000 shares daily and targets the intermediate end of the yield curve, thereby maintaining an effective duration of 5.2 years. The ETF has a 30 Day SEC yield of 2.09% so it isn’t exactly a big yielder although it arguably is a more stable choice in the segment.

Written By Eric Dutram From Zacks Investment Research   

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.

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