Investing in Junk Bond ETFs

Junk bonds, also known as high-yield bonds, are bonds that are rated below investment grade. These types of fixed-income investments have a higher risk of default but can offer investors significantly higher returns. Junk bonds can be identified by their low credit ratings which are generally labelled as Ba[1] or lower by Moody's, or BB[+] or lower by Standard & Poor's. The lower the rating, the higher the default risk.

The two categories of junk bonds

The market's jargon breaks down junk bonds into two broad categories — "Fallen Angels" and "Rising Stars". Fallen Angels junk bonds are those that at one time in the past were considered as investment grade and are now flagged as “junk”. On the other hand, Rising Stars are bonds that are rated as junk bonds but could become investment grade due to improvement in the economic conditions or the company's financials.

Historically, junk bonds have a yield of around 5% above 10YR U.S. Treasury bonds (Source: Federal Reserve Bank of St. Louis). When this spread tightens, junk bonds become more expensive. But they may fall out of favor if they no longer justify the risk incurred. Yields can be affected by macroeconomic conditions, interest rate environment, or the issuing company's financial stability.

Should you buy junk bonds?

Like any investment, risk and return for junk bonds go hand in hand. Junk bonds carry risk since there are no guarantees that the issuers will be able to pay interest and principal in a timely manner. As a result, junk bonds pay a higher yield than their investment-grade counterparts to help compensate investors for the higher risk incurred. Lower-rated companies must therefore pay more to fund their operations.

Pros of owning junk bonds

• Higher rates of return compared to investment-grade bonds.
• Bondholders are paid back before stockholders in case the company went under.
• Junk bonds — like most corporate bonds — include periodic payments (coupons) until they mature.
• Junk bonds prices could appreciate if the company's financial situation improves.

Cons of owning junk bonds

• Higher risk with the bond issuer missing an interest payment compared to investment-grade bonds.
• Junk bonds can be subject to a partial or total loss of value if the issuer's credit rating deteriorates or if the company falls into bankruptcy.
• Junk bonds involve more liquidity risk as their issue size is relatively small compared to that of investment-grade issues. In addition, investors are more reluctant to purchase high-yield bonds, which can make it difficult to resell.
• A sharp increase in interest rates can affect all types of bonds, including high-yield bonds. If the interest rate increases, the value of the bond will decrease, and vice versa.

How to invest in junk bonds?

Investors can gain exposure to junk bonds through:

• Buying individual junk bonds:  some online brokers offer that option on their platforms. However, given the level of risk involved — it is not recommended for less experienced investors to buy an individual bond. Diversification is key when it comes to risky assets such as junk bonds. 
• Investing in junk bond mutual funds: retail investors can also attain exposure to junk bonds through mutual funds that offer diversification benefits though some portfolios are concentrated. However, they often require a large minimum initial investment, which can be a deal-breaker for investors with low investment capital. 
• Investing in Junk Bond Exchange-Traded Funds (ETFs): Bonds ETFs are the easiest route to gain exposure to a highly diversified, liquid, and transparent bond portfolio. Junk Bonds ETFs are bought and sold like stocks and give you exposure to a large array of underlying assets at once.

Investing in Junk Bond ETFs

If you have opted for Junk Bond ETFs, then there are certain aspects of a bond fund you need to be aware of to compare between all the available options.

• Active or Passive: passive Junk Bond ETFs seek to track an index designed to measure the performance of publicly issued high yield corporate bonds. Meanwhile, active Junk Bond ETFs are managed by a dedicated professional investment management team that oversees the fund’s efficiency. They use their knowledge and experience to create bond portfolios that reflect current market conditions. 
• Expense Ratio: The expense ratio or (T.E.R) is the percentage ETF issuers will charge you every year for owning their ETFs. These fees are used to cover the fund's administrative, management, advertising expenses. So, if the TER is 1% and you have $10,000 worth of ETF shares, that means you will pay $100 in fees every year. 
• Number of Holdings: a Junk Bond ETF with 1,000 underlying securities is likely to be less risky than a Junk Bond ETF holding 50 bonds. A higher number of holdings could provide a cushion of safety against default risks. 
• Average Coupon: the market value-weighted average coupon of the bonds held in a portfolio. 
• Currency Denomination: dollar-denominated vs. local currency — Dollar-denominated simply means that the bonds are issued in U.S. dollar. 
• Current Yield: a bond's annual return based on its annual coupon payment and current price (as opposed to its original price or face price). It is calculated by dividing the annual interest earned by the current price of the bond. The current yield at the portfolio level can be obtained using the current yields and market values of underlying securities.
• Fund Distribution Yield: the sum of the most recent distributions within the past 365 days divided by Net Asset Value (NAV) per share, expressed as a percentage. 
• Distribution Frequency: it is when you get paid your share of the coupons. It could be monthly, quarterly, or yearly.
• Average Maturity: the market value-weighted average maturity of the bonds and loans in a portfolio, usually expressed in years.
• Average Yield to Worst: it can be defined as the average minimum yield that can be received on a bond, assuming the issuer does not default on any of its payments.
• Yield to Maturity: the market-weighted average rate of return anticipated on the bonds held in a portfolio if they were to be held to their maturity date.
• Sector Breakdown: the share of the market value of bonds issued by companies in each sector (energy, consumer discretionary, industrials, etc).
• Regional Breakdown: shows how the portfolio is diversified across bonds issued in various areas or countries (e.g., 30% Europe, 20% U.S., etc.…). Calculated as the sum of the market value of the bonds issued from a certain region, divided by the fund's assets.
• Fund Quality Breakdown: shows how the portfolio is diversified across bonds with different credit ratings (e.g., 38% BB, 10% B, 25% CCC or lower, etc.…). Calculated as the sum of the market value of the bonds issued that share the same credit rating, divided by the fund's assets.
• Fund Maturity Breakdown: shows how the portfolio is diversified across bonds of various maturities (3-5 years, 5-7 years, etc.…). Calculated as the sum of the market value of the bonds that share the same maturity, divided by the fund's assets.
• Performance: the fund's NAV performance calculated over various time periods (1 month, 1 year, year-to-date, etc.…).

Where to find the right Junk Bonds ETFs?

Trackinsight recently released its fixed income investing channel in partnership with iShares and Jane Street. It provides investors access to the fixed income ecosystem. It includes a comprehensive screener allowing users to quickly find the ideal bond ETF for their portfolios.  For investors who would like to explore which junk bonds are available — they are three steps away.

1. Open the Trackinsight Fixed Income ETFs screener 
2. In “Credit Rating”, select “High-Yield” 
3. Use the box above the results list to add your investment constraints 

Other criteria are also available such as the investment purpose, credit rating, maturity, geographical focus, and the bond denomination currency. Once all filters are applied, investors can sort the results shown by assets under management, total expense ratio or Trackinsight rating (assessing the replication accuracy of the underlying index) to find the best option.

Examples of Junk Bonds ETFs

• iShares iBoxx $ High Yield Corporate Bond ETF (HYG)
• iShares Broad USD High Yield Corporate Bond ETF (USHY)
• SPDR Barclays High Yield Bond ETF (JNK)
• iShares € High Yield Corp Bond UCITS ETF (IHYG)
• iShares 0-5 Year High Yield Corporate Bond ETF (SHYG)
• X-trackers USD High Yield Corporate Bond ETF (HYLB)
• VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL)
• SPDR Bloomberg Barclays Short Term High Yield Bond ETF (SJNK)
• iShares $ High Yield Corp Bond UCITS ETF (SHYU)
• iShares Fallen Angels USD Bond ETF (FALN) 

Click here to see the full list (Note: currently only European-domiciled Bonds ETFs are visible in the screener. All Bonds ETFs will be added soon.

Want to learn more about bond ETFs? We have the perfect guide to start your fixed-income education. 

Visit Trackinsight’s fixed income investing page. 

Find fixed income ETFs with Trackinsight’s fixed income ETF screener.