Van Eck Files For Hedged Junk Bond ETF

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November 20, 2012 12:15pm ETF BASIC NEWS

Eric Dutram: Although there are some very real worries over a bond bubble, investors are clearly not giving up on fixed income just yet. This asset class has seen huge inflows as of late, and with continued uncertainty in the markets, this trend could continue until the end of the year.

This could be especially true in the junk bond market as this space is known for its outsized yields, a factor that has made them extremely important during this low rate environment. These securities often have payouts that are double or triple mid range Treasury bonds, making them ideal for those who are starved for current income (see Seven Biggest Bond ETFs by AUM).

Yet when rates inevitably turn, these junk bonds look to be hit, and hit hard thanks to their higher risk nature. This is what investors saw during the crisis of 2008, and with below-investment grade securities trading at all-time highs, they could find themselves especially susceptible to interest rate risks this time around.

For this reason, investors seeking high yields in this corner of the market may want to consider a hedged approach which eliminates at least some of the risk from the equation—even if it reduces yield or appreciation potential (read High Yield Bond ETF Showdown: ANGL vs. QLTB).

If investors are seeking this type of exposure, a proposal from Van Eck for a new junk bond ETF could be of some interest. In the SEC filing, the company revealed initial plans for the Market Vectors High-Yield/Treasury Bond ETF, in order to help mitigate some of the risks highlighted above, while still focusing on junk bonds.

The proposed ETF still needs to meet SEC approval, but it could be a step in the right direction for investors who are concerned about a bond bubble but still want high yielding securities. While we still don’t have a great deal of information on this proposed ETF—ticker symbol and expense ratio were not revealed—we have highlighted some of the key points below:

The proposed fund will track the Market Vectors High Yield/Treasury Bond Index, which looks to provide exposure to below investment grade corporate bonds, denominated in U.S. dollars. It will also, via Treasury notes and bonds, hedge against the price sensitivity of junk bonds by shorting U.S government securities.

Investors should also note that the fund will include securities that have an average of a below investment grade rating from the three major issuers, while it will also include foreign bonds—in dollars—as well. Some of the nations that the filing indicated may be a part of the fund include G10 countries, or other Western European developed nations (read Follow Buffett with these Developed Market Bond ETFs).

With this approach, the ETF looks to hedge out some of the broad interest rate risk from the bond environment and allow investors to focus in on credit risk. While this technique could hurt from a price appreciation standpoint if yields continue to fall, it could really pay off for investors if we see a broad rise in interest rates, as it would help this proposed fund to outperform its junk bond counterparts (see HYEM: The Best Choice in Junk Bond ETFs?).

Either way, the ETF still has to pass some significant regulatory hurdles in order to reach the market so it could be a while before this ETF is available. In that time, investors don’t really have a whole lot of other options, but a look to low duration securities seems to be the best bet until Van Eck can obtain the regulatory approval for this innovative ETF.

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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