High-yield bond ETFs backed by cash-rich corporates

May 16th, 2012 | By | Category: Fixed Income

Recent gloomy economic data points to the prolonged need for accommodative monetary policy – and thus low interest rates – which should bode well for high-yield bonds backed by cash-rich corporates. At least, that’s the view of Tim Gardner, Co-Manager of Legal & General’s Multi-Manager fund range, who last week moderately increased the allocation to high-yield bonds within his funds, in part funded by trimming equities.

High-yield bond ETFs backed by cash-rich corporates

According to Tim Gardner of L&G's multi-manager range, “income-seeking investors are likely to continue to have to look outside of core government bond markets and towards assets such as high-yield bonds.”

Gardner says that: “Whilst the recent flare up in Europe clearly demonstrates the risks still posed from the European sovereign debt crisis, yields on high-yield bonds (and their spreads over government bonds) continue to be above what we estimate to be fair-value levels, especially given the healthy balance-sheet position many corporates find themselves in today and our assumption of continued, albeit slow, global economic growth.”

“As we have noted before, corporates are cash rich and have benefited from terming out their debt,” says Gardner.

To illustrate this, Gardner points to a multitude of data in the US, the world’s largest high-yield market. First, 78% of total non-financial corporate debt is now long term in nature, up from 72% and 66% five and ten years’ ago respectively. Second, the ratio of liquid assets to short-term liabilities is now at 59%, up from 42% five years’ ago and the highest level since 1955. And third, US corporate sector as a whole is sitting on over $2 trillion of liquidity – this figure having doubled in the last decade.

FEATURED PRODUCT

Pimco Short-Term High Yield
Corporate Bond Index Source ETF (STHY)

– Diversified exposure to the short-maturity segment
of the US high-yield corporate bond universe

– Returns of the short-term segment of the high-yield
market have typically been in line with equities,
but with approximately half the volatility

– Leverages Pimco’s experience and expertise in both
portfolio optimisation and global high-yield investing

– Physically-backed, UCITS compliant, London listed,
UK Reporting Status, eligible for ISAs

– TER of just 0.55%, considerably less than
traditional high-yield bond funds

Gardner believes that recent data prints out of the US, most notably employment numbers, and elsewhere have disappointed, which, together with the looming fiscal cliff coming at the end of the year, continue to point to a need for extremely accommodative monetary policy – and hence low interest rates – for some time to come.

According to Gardner: “This ultimately means income-seeking investors are likely to continue to have to look outside of core government bond markets and towards assets such as high-yield bonds in order to fulfil their requirements.”

High-yield bonds also look relatively cheap when compared to default assumptions being priced in against market forecasts. Based on the projections of Moody’s Credit Transition Model, which has a fairly decent record of predicting default rates, 2.8% of US high-yield issuers will default in the coming year.

According to a recent WSJ article: “Assuming investors recover 40 cents for each dollar invested in high-yield bonds that default, then Moody’s prediction translates to losses totalling 1.7% for US high-yield bonds over the coming year. This means that high-yield investors are currently being compensated more than 3.7 times over if defaults were the only risk that bondholders bear.”

Overall the case for the inclusion of high-yield bonds within a portfolio looks compelling. For investors looking to gain exposure to this asset class, there a number of London-listed high-yield bond ETFs worth considering (see below). For investors based in Europe, many of these funds are cross-listed on European exchanges (Deutsch Borse / Xetra, Euronext, Borsa Italiana etc) and/or are registered for sale and distribution in European countries.

US High Yield

Pimco Short-Term High Yield Corporate Bond Index Source ETF (STHY)
The Pimco Short-Term High Yield Corporate Bond Index Source ETF aims to replicate the performance of the BofA Merrill Lynch 0-5 Year US High Yield Constrained Index by investing in a range of securities broadly similar to the constituents of the index. The BofA Merrill Lynch 0-5 Year US High Yield Constrained Index tracks the performance of short-term US dollar-denominated sub-investment-grade corporate debt issued in the US domestic market with less than five years remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of $100 million, issued publicly. Allocations to an individual issuer will not exceed 2%. London (LSE) listed, TER 0.55%.

iShares Markit iBoxx $ High Yield Capped Bond ETF (SHYU)
The iShares Markit iBoxx $ High Yield Capped Bond ETF tracks the Markit iBoxx USD Liquid High Yield Capped Index. This index consists of the most liquid US dollar-denominated corporate bonds with a sub-investment-grade rating, while maintaining a focus on UCITs eligibility. The maximum original time to maturity is 15 years and the minimum time to maturity is three and a half years for new bonds to be included and three years for bonds that already exist in the index. For diversification purposes the weight of each issuer in the index is capped at 3%. London (LSE) listed, TER 0.50%.

European High Yield

SPDR Barclays Capital Euro High Yield Bond ETF (SYBJ)
The SPDR Barclays Capital Euro High Yield Bond ETF tracks the Barclays Capital Liquidity Screened Euro High Yield Bond Index. This index includes fixed-rate bullet, puttable, and callable senior debt publicly issued in the Eurobond and index-member domestic markets. The maturity must be between one and up to (but not including) 15 years, and fixed-to-floating rate securities will not be included. The principal and coupons must be denominated in EUR and have a minimum par amount outstanding of €250 million. London (LSE) listed, TER 0.45%.

iShares Markit iBoxx Euro High Yield Bond ETF (IHYG)
The iShares Markit iBoxx Euro High Yield Bond ETF tracks the Markit iBoxx Euro Liquid High Yield Index. This index offers exposure to the largest and most liquid euro-denominated corporate bonds with sub-investment grade rating. Only bonds with a minimum amount outstanding of €250 million are included in the index. The maximum original time to maturity is 10.5 years and the minimum time to maturity is 2 years for new bonds to be included (no minimum restriction for bonds already in the index). For diversification purposes the weight of each issuer in the index is capped at 5%. London (LSE) listed, TER 0.50%.

Lyxor ETF iBoxx EUR Liquid High Yield 30 (YIEL)
The Lyxor ETF iBoxx EUR Liquid High Yield 30 ETF tracks the Markit iBoxx EUR Liquid High Yield 30 Total Return Index. This includes 30 of the most liquid bonds making up the Markit iBoxx EUR High Yield Core Cum Crossover index, representing the scope of high-yield, euro-denominated non-government bonds. London (LSE) listed, TER 0.45%.

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