Understanding High-Yield Fund Performance by Matthew Tucker, CFA, BlackRock Blog
Matt Tucker discusses the performance of high-yield exchanged traded funds and how they compare to some other high-yield investments.
If you follow bond markets—and maybe even if you don’t—you’ve probably been hearing a lot about high-yield. Some say this so-called “junk” spells doom. Others say there’s still value there, but you must be selective. We would agree that selectivity is crucial in this space—after all, these are the bonds of companies with widely diverging performance. For exchange traded fund investors, that means knowing what you own: Not all high-yield ETFs are the same. I’d like to take a look at one high-yield investment in particular to set the stage for you.
High-Yield and Investing for the Long Run
Let’s start by taking a look at performance. How do funds like the iShares iBoxx $ High-Yield Corporate Bond ETF (HYG) stack up against other high-yield investments out there for long term investors? Year-to-date (through 10/31/15) HYG has returned -0.61 percent vs. -0.46 percent for the Markit iBoxx USD Liquid High-Yield Index that it seeks to track.
Standardized Performance as of 9/30/2015
|Fund NAV Total Return||-4.43%|
|Fund Market Price Total Return||-4.53%|
|Index Total Return||-3.98%|
|Fund NAV Total Return||5.16%|
|Fund Market Price Total Return||5.02%|
|Index Total Return||5.37%|
|Fund NAV Total Return||4.98%|
|Fund Market Price Total Return||4.97%|
|Index Total Return||5.38%|
(as of 7/1/2015)
The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by visiting www.iShares.com or www.blackrock.com, or by clicking here. Shares of ETFs are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. Market returns are based upon the midpoint of the bid/ask spread at 4:00 p.m. eastern time (when NAV is normally determined for most ETFs), and do not represent the returns you would receive if you traded shares at other times. Index returns are for illustrative purposes only. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index.
As HYG is an index fund, its objective is to track its index (less management fees). HYG’s management fee of 50 basis points works out to 42 basis points for 10 months. As the fund is trailing by 15, we see that it is doing slightly better than its index after accounting for fees.
Looking at this over the past 5 years we see that HYG has returned 5.28 percent annually versus 5.53 percent for the iBoxx index. HYG trails by 25 basis points, and so again is just ahead of its index after accounting for fees.
So HYG has tracked its iBoxx index fairly consistently through time. But what does the iBoxx index represent, and how does it track to other high-yield investments? The iBoxx index constituents represent the larger high-yield bonds in the market, specifically those with more than $400 million outstanding that come from issuers with more than $750 million outstanding. This differs from broad indices such as the Barclays U.S. Corporate High-Yield Index or the BofA Merrill Lynch US High-Yield Index, both of which include smaller bonds. iBoxx thus has a large issue bias, and does not capture the performance of smaller, often less liquid bonds. If we break down the Barclays index we can see how the performance of larger and smaller high-yield bonds differs over time:
Barclays U.S. Corporate High-Yield Index Return
Comparing and Contrasting High-Yield Indices
How will the iBoxx index, and by extension HYG, compare against broader high-yield indices? It really depends on the performance of those smaller issues in the market. If those issues are doing well, the iBoxx index will likely trail indices like Barclays and Merrill that represent the broad market. And if larger issues are doing better, then iBoxx should lead. One other important difference between iBoxx and other indices: iBoxx includes the transaction costs of monthly rebalancing in the index return calculation. In other words, all else being equal, iBoxx would likely show a lower return. This means the iBoxx index returns are calculated more similarly to an actual high-yield bond portfolio, which would also incur transaction costs.
If you think about it, this large versus small difference is very similar to what we find in the equity markets. The Russell 1000 Index represents large cap equity names, while the Russell 3000 Index includes those same names plus 2000 smaller issues. As such, we wouldn’t expect Russell 1000 and Russell 3000 to perform the same. Russell 1000 does well when large cap names outperform, and would be expected to trail the broad Russell 3000 market when large cap underperforms smaller issues. This is the same in the high-yield market. We expect the iBoxx index to outperform broader indices like those from Barclays or Merrill during some markets, and trail in others.
As many active high-yield mutual funds invest in the smaller high-yield bonds, the comparison is similar. But many of those mutual funds may also invest in sectors outside the high-yield market such as bank loans, convertible bonds and preferred stock as a way of seeking to outperform their index. As of 9/30/15 the high-yield mutual funds in Morningstar’s universe had an average of 2.3 percent equity holdings. Comparing the iBoxx index to these funds isn’t a case of apples versus oranges; it’s a case of apples versus an entire fruit basket. We would expect performance differences through time. As of 10/31/2015 HYG had outperformed 51 percent of active mutual fund managers over the prior 5 years. (This is according to Morningstar; HYG’s performance was compared to the performance of the A-Share classes of all managers in the Morningstar US Open-Ended High-Yield Bond Category.) It landed right in the middle, better than some funds in the market and worse than others.
The Bottom Line: Deciding What’s Best for Your Objectives
To be fair, not all high-yield ETFs perform the same, and this comparison is only for HYG. Investors who use other ETFs would have to crunch the numbers to see if those funds performed in a similar way.
It’s not a question of whether index or active is “better” or “right”, but rather a question of what kind of exposure you seek. If you want to go with the fruit basket and you can find a good active manager who you believe can generate outperformance, then an active mutual fund may be the right choice. If you prefer to have more control of your investment and want to invest only in high-yield bonds, then a high-yield index fund may be the right choice—you are giving up the potential gains from one of the 49 percent of managers who outperformed the ETF, but also avoiding the potential losses from picking one of the 51 percent who didn’t. Either way, pick the investment that matches your investment style and investment objectives.