Top 5 High Yield Bonds ETFs of 2021

During the first weeks of 2022, financial markets have been volatile and unpredictable. Overall global stock markets (MSCI ACWI) are down 7% and the S&P500, the barometer of the US economy has plummeted by 9% through January. With equity markets suffering, many investors are beginning to turn their attention to the other side of the balance sheet and focus on fixed income securities – particularly those in the high yield space. Before starting, if you want to learn the basics of fixed income, we wrote the perfect article to do just that.

2021 was a tough year for bond ETFs, recording an average performance of -2%. Despite the weak performance, high yield bond ETFs managed to remain in positive territory with an average performance of 1%. In total, high yield bond ETFs collected 14 billion in assets through 2021.

What is high yield?

High yield refers to the credit rating of the bond issuer. Credit ratings are one of the most important metrics to assess fixed income securities as they reflect the ability of an issuer/issue to repay its debt and interest. Long story short, credit rating agencies perform a thorough analysis on the company, its financial health, the industry in which it performs, or any variable that might affect its capacity to pay back its debts. Following this analysis, the company is given a grade that goes from D which stands for default, to AAA which is the credit rating of large, developed governments. If you want to learn more about how entities’ creditworthiness is evaluated, Trackinsight has covered the subject in this article.

In return for taking on higher risk by lending money to companies with lower credit ratings, the investor is compensated by a higher yield. Investment-grade bonds on the other hand deliver a lower yield but have a lower credit risk. Investors usually invest in fixed income to diversify their portfolio and decorrelate from stock markets. Buying high yield instruments is a way to keep the characteristics of fixed income asset class such as the low volatility and get returns that can be similar to stocks’.

How will the upcoming rate hikes affect high yield bonds?

With the upcoming rate hikes that will be implemented by Central Banks across the world, some higher-yielding securities prices are likely to drop by a significant amount, meaning it might be the perfect opportunity for you to start investing in high yield bonds. Bond prices and interest rates have a very special relationship, when interest goes up, bond prices go down and inversely. This is because investors could go into the market and purchase bonds with higher coupon rates and therefore earn more interest compared with existing bonds. On the contrary, if interest rates drop, coupons of newly issued bonds would also drop, which would make already-issued bonds with higher coupons more valuable. Be careful though, you need to remember high yield securities pay a higher yield because they are more likely to default compared with investment-grade instruments. It is therefore very important to not put all your eggs in the same basket. ETFs comprise several high yield securities and hence do some part of the diversification for you.

List of Top 5 High Yield Bond ETFs of 2021

To help you begin investing in High Yield Bonds ETFs, we made a list of 5 ETFs that saw the highest level of inflows in 2021.

1. iShares Fallen Angels USD Bond ETF (FALN)  +$4.5 billion
2. iShares Barclays USD Asia High Yield Bond Index ETF (09P) +$2.2 billion
3. First Trust Senior Loan ETF (FTSL) +$1.8 billion
4. iShares Broad USD High Yield Corporate Bond ETF (USHY) +$1.4 billion
5. VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL) +$1.2 billion

1 - iShares Fallen Angels USD Bond ETF (FALN) +$4.5 billion

The iShares Fallen Angels USD Bond ETF is a passive ETF giving investor exposure to USD-denominated high yield corporate bonds that were previously rated investment grade.

The Bloomberg US High Yield Fallen Angel 3% Capped Index, the index it follows, is focused on US bonds and ensures diversification through a capping methodology. This means a single issuer can only represent a maximum of 3% of the ETF. However, it is interesting to note a concentration of bonds issued by energy (23%) and consumer cyclical (17%) companies. All maturities are represented in the ETF.

The TER of this ETF is 0.25%, more than 2 times lower than its category average of 0.52%. The ETF performed well through 2021 with a total return of 5.77%.

What does “fallen angel” mean?

A fallen angel is a term often used to describe companies that were previously rated investment grade and that had their rating downgraded to high yield. They are a popular segment in the bond markets because fallen angel securities are considered safer than other high yield securities while offering a higher yield than investment-grade companies. Hence, they are a good trade-off between investment grade and high yield.

2 - iShares Barclays USD Asia High Yield Bond Index ETF (09P) +$2.2 billion

Asian bonds are popular for their yields. They offer a good yield/risk trade-off for investors. The iShares Barclays USD Asia High Yield Bond Index ETF tracks the Bloomberg Asia USD High Yield Diversified Credit Index. The index is constituted of USD-denominated high yield bonds issued by Asian governments as well as businesses based in Asia. Because bonds are denominated in USD, they are not subject to the risk inherent to local Asian currencies.

Like most Asian funds, Chinese securities have a strong footprint. Indeed, about a third of the fund is composed of Chinese bonds, followed by Indian instruments with 17% weight.

Most bonds comprised in the fund have a maturity ranging between 1 and 10 years.

In terms of costs, the TER of this ETF is 0.50% which is close to the 0.52% average TER of High Yield Bond ETFs. Unfortunately, as we saw Chinese bond market faced difficult times in 2021, which led to a negative performance of -12.95%.

3 - First Trust Senior Loan ETF (FTSL) +$1.8 billion

Unlike the two previous funds, the First Trust Senior Loan ETF is actively managed. It sets its focus on senior loans. Senior loans are debts issued by companies to banks, they are called “senior” because, in the event of default, the loans are paid out with priority to other debts. Typically, senior loans have floating rates but can also be structured as fixed rates. In the case of the First Trust Senior Loan ETF, the fund focuses on floating rate senior loans.

Most securities are rated between B+ and B- with 40% of the fund invested in securities rated B. Thus, investors should be aware of the default risk of underlying securities.

Moreover, the fund is concentrated in the technology and health care sector with about 50% of the fund invested in these sectors.

This fund is more expensive than the competition with a TER of 0.88% compared with 0.82% for the average high yield actively managed ETF. Yet, this is still way cheaper than mutual funds which charge on average 2 to 3%. The fund recorded a performance of 4.02% in 2021.

4 - iShares Broad USD High Yield Corporate Bond ETF (USHY) +$1.4 billion

The iShares Broad USD High Yield Corporate Bond ETF gives passive exposure to the high yield American USD-denominated corporate bond market through the replication of the ICE BofA US High Yield Constrained Index. It is a “vanilla” high yield ETF, providing exposure to high yield bonds without focusing on a specific segment of the market. Nevertheless, investors should note that CCC-rated bonds account for approximately 10% of the fund.

Since it’s passive and not focused on a specific segment, this ETF is very cheap, with 0.22% TER, it’s more than 2 times less expensive than the competition’s average. The ETF performed well through 2022 with a return of 5.14%.

5 - VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL) +$1.2 billion

This ETF is another choice to replicate the performance of fallen angel high yield bonds. However, compared with iShares’ ETF (FALN) the VanEck Vectors Fallen Angel High Yield Bond ETF replicated an index with a 10% capping instead of 4%. This means one issuer could potentially account for 10% of the fund. For example, as of the end of January 2022, bonds issued by Occidental Petroleum Corp represented approximately 10% of the fund.

While less expensive than the average competitor, the fund is still more expensive than FALN with a TER of 0.35%. Why does it still collect money then? Well, because as the index it replicates is not the same, neither is the performance. iShares’ ETF recorded a 5.77% performance across 2021 and VanEck a 7.65% return.

Concluding remarks about High Yield ETFs

Fixed income is a wide asset class that groups very different instruments that behave differently depending on market conditions. More specifically, when markets are volatile but economic prospects are still favorable, high yield securities are useful to decorrelate from stock markets while keeping an attractive level of yield. The major setback of high yield instruments is the default risk of issuers, investors should always be careful about this matter and diversify their assets. High Yield ETFs are powerful tools that help investors diversify across a segment of the market in only one transaction which makes ETFs a time and cost-efficient solution.