IndexIQ has launched the IQ S&P High Yield Low Volatility Bond ETF (NYSE: HYLV), a factor-based fixed income ETF designed to provide exposure to high yield bonds from US issuers while capturing returns attributable to investing in the low volatility factor.

The IQ S&P High Yield Low Volatility Bond ETF is Index IQ’s latest fixed income ETF launch to target a factor exposure following the launch in May 2016 of two ETFs tracking bond sectors with the highest momentum.

Underlying the ETF is the S&P US High Yield Low Volatility Corporate Bond Index, which follows a rules-based approach to capture the performance of US high yield corporate bonds with the potential for lower relative volatility and greater liquidity.

To construct the index, the methodology initially screens the bonds within the S&P US High Yield Corporate Bond Index to include only fixed-rate coupon bonds with more than $400m outstanding.

The index then seeks to identify those high yield bonds that are deemed to have less credit risk, as determined by a formula that combines a bond’s spread and duration into a measure called “Marginal Contribution to Risk” (MCR). Bonds with a higher MCR are deemed to have higher credit risk and are excluded from the investment universe. The index is weighted by the market value of its constituent bonds with a cap of 3% per issuer.

Research from New York Life Investment Management, IndexIQ’s parent company, and Standard and Poor’s has found that this methodology typically lowered the volatility of returns and exposure to defaults.

As of 31 January 2017, the index has 452 constituents, a yield to maturity of 4.6%, and a yield to worst of 4.4%. The index’s effective duration is 4.4 years.

The index has generally underperformed its benchmark, the S&P US High Yield Corporate Bond Index. It has returned 8.6% over the past year and 5.1% per annum over the past five years, compared to 19.5% and 6.6% per annum for the benchmark over the same periods respectively.

It does perform better on risk metrics however, recording an annualized standard deviation of 4.4% and 4.5% over the past three and five years respectively – its benchmark recorded 6.0% and 5.3% annualized standard deviation over the same periods. This has led to a superior Sharpe ratio of 1.00 compared to its benchmark Sharpe ratio of 0.79 for the last three years; however, its Sharpe of 1.13 underperformed the benchmark Sharpe of 1.25 over a five year period.

Looking at the below graph of historical index performance for the S&P US High Yield Low Volatility Corporate Bond Index and its benchmark, one can see the low-volatility strategy is particularly useful in protecting value during periods of significant market downturn, such as in late 2008/early 2009 and also in mid-to-late 2015.

Source: S&P Dow Jones.

The ETF is the latest entry into the factor-based fixed income space by IndexIQ following the launches of the IQ Enhanced Core Bond US ETF (NYSE: AGGE) and the IQ Enhanced Core Plus Bond US ETF (NYSE: AGGP) in May 2016. (See: “IndexIQ launches first smart beta fixed income ETFs“)

These ETFs adopt a ‘fund of funds’ structure, investing in fixed income sector ETFs that are displaying the strongest positive total return momentum. AGGE is restricted to investing in Treasuries and US investment grade corporate  bonds, while AGGP has the added flexibility of allocating to the US high yield and US dollar-denominated emerging market debt, depending on momentum indicators. Collectively the ETFs have amassed approximately $330m in AUM.

Adam Patti, Chief Executive Officer at IndexIQ, commented: “With HYLV, as with AGGE and AGGP, we are bringing a new class of solutions to market — products that allow investors to boost the income generated by their bond portfolios while reducing risk and volatility.  The launch of this fund is the latest step in our long term strategy, to engage our network of independent investment boutiques to build innovative solutions with investors’ and advisors’ investment goals in mind.  We’re excited to bring HYLV to market, providing access to the combined expertise and breadth of our New York Life Investment Management’s world class offerings.”

The ETF is sub-advised by MacKay Shields, a $95bn fixed income boutique wholly owned by New York Life Investment Management.