Cutting Your Losses? With High-Yield ETFs, Maybe It’s Time

Cutting Your Losses? With High-Yield ETFs, Maybe It’s Time

Cutting Your Losses? With High-Yield ETFs, Maybe It’s Time by Gershon Distenfeld, AllianceBernstein

If you bought a high-yield exchange-traded fund (ETF) over the past two years and still own it, you’ve probably lost money. But don’t fret. This might be an ideal time to change course.

Let’s start with the bad news. Using JNK or HYG—the two largest high-yield ETFs—to get long-term exposure to the market hasn’t worked out well over the last few years.

As the display below illustrates, there’s a 96% probability that investors who bought either of these instruments since the start of 2013 suffered a capital loss if they still owned them on October 30, 2015. The chances of a loss of 5% or greater were 87% for JNK and 82% for HYG. Investors who waited until the start of 2014 probably didn’t fare much better.

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To be fair, active high-yield strategies have also struggled over the past 18 to 24 months as the credit cycle has moved into its twilight stage. Fears about US interest rates, falling oil prices and rising defaults have made investors anxious and credit markets volatile.

But over a longer time period, active managers have a pretty good track record. High-yield ETFs, on the other hand, are a bad long-term investment. Since 2008—shortly after their inception—JNK and HYG have delivered lower returns and higher volatility than actively managed mutual funds.

Time to Harvest a Tax Loss?

Why bring this up now? Simply because tax season is upon us. By selling loss-making investments now, advisors can reduce their clients’ overall capital gains tax. More importantly, investors can redeploy these savings in new strategies with higher potential returns.

Some investors may be tempted to harvest losses on these ETFs and then rotate out of high yield altogether. We think that would be a mistake. Instead, investors who have an allocation to high yield might want to consider redirecting it to actively managed funds.

We think there are still attractive opportunities in high yield. In our view, active managers, who can draw on detailed credit analysis to pick and choose where to invest, are in the best position to take advantage of them.

High-yield ETFs can’t really do that. For one thing, they track an index, so managers can’t pick and choose their exposures. More importantly, they have a number of hidden costs that weigh on performance.

Getting the right type of high-yield exposure is critical because we expect elevated volatility to persist for some time to come. Investors will have to remain vigilant when it comes to credit quality, manage liquidity risk and be flexible enough to seize opportunities as they arise.

When it comes to high yield, we don’t think ETFs are up to these challenges. A skilled active manager gives investors a better chance of managing their risks and increasing their potential returns.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

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