- Ultra-low interest rates make it difficult for investors to earn yields in excess of inflation
- High yield bonds can be a source of income in today’s market
- iShares has numerous bond ETFs that can help investors target different segments of the high yield bond market, depending on their needs and preferences
The past year was marked by many extraordinary events in the financial markets.
Coronavirus worries injected sudden market volatility into global financial markets and prompted the most jarring asset price swings since the great financial crisis. In response, lobal central banks engaged in a variety of actions to provide stimulus to the economy to soften the impact of COVID-19, including the Federal Reserve reducing its policy interest rate to near zero to lower the cost of credit and improve liquidity for borrowers.
For savers, a low-rate environment means it is increasingly difficult to generate returns on bonds that overcome inflation. Consider that the consumer price index is 1.2% year-over-year, but the Fed funds target rate is 0-0.25% — down from 2.25-2.50% as recently as July 2019.1
The BlackRock Investment Institute (BII) recently endorsed high yield bonds in 2021 for income-seeking investors. Higher-yielding bonds can help investors reach their fixed income goals, and this article walks through many of the questions I get often about how yield bond exchange traded funds (ETFs) can fit into income-seeking portfolios.
Where’s the yield?
Source: US Federal Reserve, ICE and BlackRock as of 11/30/2020. Fed Fund Target Rate represented by the upper bound of the range, U.S. Treasuries represented by ICE U.S. Treasury Core Bond Index, Core Bonds represented by the Bloomberg Barclays U.S. Aggregate Bond Index, Investment Grade (IG) Corporates represented by the ICE BofAML U.S. Corporate Master Index, High Yield Corporate represented by the ICE BofAML U.S. High Yield Constrained Index
Role of fixed income in a portfolio
For starters, there are three primary roles that bond ETFs can play in a portfolio.
- Income: Bonds can be used for income, which in today’s market can help investors add credit risk to boost yield. Corporate bonds generally pay a yield above government bonds. The extra yield premium varies based on a corporate issuer’s credit risk, time to maturity and overall market conditions.
- Capital preservation: Bond prices tend to not fluctuate as much as stock prices and lower duration bonds can help preserve investors’ savings. If you are more concerned about return-of-capital rather than return-on-capital, then it’s best to stick to bonds with shorter maturities.
- Equity market diversification: Government bonds and investment grade securities tend to benefit from a flight-to-quality when the stock market declines. While these bonds yield less than below investment grade bonds, they have low correlations to the stock markets and can help balance out overall portfolio returns over time.
Investors generally need to balance out these competing roles in the portfolio to meet goals, since no single bond or bond fund can meet all these objectives. More fixed income-heavy portfolios (less than 30% stocks) will need more income to meet return objectives, while more stock-heavy portfolios (70-80% stocks) should have higher quality bonds to diversify equities. The world of ultra-low rates means that all types of investor are increasingly reliant on income to generate total return.
Different ways to invest in high yield bond markets
The first-ever high yield bond ETF, iShares iBoxx $ Liquid High Yield Bond ETF (HYG), was launched in 2007 a liquid way to track the high yield market. Ten years later, iShares Broad USD High Yield Bond ETF (USHY) launched to track an even broader high yield index. Today investors have choice with 17 iShares high yield bond ETFs that are designed to create customized income portfolios.
Each of the iShares high yield bond ETF is a bit different, and below are some of the approaches they take to help investors reach their goals:
Income with capital preservation: iShares 0-5 Year Corporate Bond ETF (SHYG) tracks an index tied to the shorter-maturity part of the market. Additionally, its index will remove bonds when they fall below $60, which a widely considered metric of distress. Removing these types of bonds can potentially reduce losses during a credit cycle.
Higher-quality high yield: iShares BB Rated Corporate Bond ETF (HYBB) invests in the BB-rated high yield corporate bond market, those just below the “investment grade” dividing line. This ETF will not have exposure to the lower rated bonds (B-rated and below) that are more likely to default.
Fallen angels: iShares Fallen Angels USD Bond ETF (FALN) offers exposure to fallen angels, bonds there are originally investment grade that get downgraded to high yield. Fallen angels tend to outperform the broad high yield market over time. These bonds also tend to get upgraded more often and have longer duration than the new issue high yield market.
Sustainable high yield: iShares ESG Advanced High Yield Corporate Bond ETF (HYXF) invests in high yield bonds from issuers with higher ESG ratings, while extensively screening out controversial industries. Sustainable bond ETFs incorporate sustainability-related considerations, which can provide more insights into fixed income solutions.
Term Maturity (iBonds): iShares iBonds ETFs are designed to mature like a bond, trade like a stock and are diversified like a fund. The High Yield & Income iBonds, with maturities from 2021 – 2026, invest in bonds that provide high income and mature in a specific calendar year. Visit the iBonds Ladder Tool to start building a high yield bond ladder.
Summing it up
The BlackRock Investment Institute expects interest rates to stay low for the foreseeable future as the global economy rebounds from the effects of the pandemic. This market environment complicates the options for yield-seeking investors. iShares ETFs offer myriad approaches for seeking income in an easy-to-trade, on-exchange format.
Originally Posted on December 22, 2020 – Six Styles of High Yield Bond ETFs
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1U.S. Bureau of Labor Statistics (as of Dec. 10, 2020); Federal Reserve Bank of New York (as of Dec. 8, 2020).
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Investing involves risk, including possible loss of principal.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.
Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.
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