High-Yield ETFs in a Cooling Market: Proceed With Caution
- Are popular junk bond and dividend ETFs like USHY and SCHD at elevated risk?
- With recession risk rising, it's crucial to review weightings and maintain defensive ballast in portfolios.
As economic data increasingly suggest a slowdown and a potential recession looming by 2026, now is an opportune time for advisors and investors to critically assess the risk within their portfolios, particularly concerning high-yield ETFs and related investments.
This includes both high-yield (junk) bond ETFs, such as the iShares Broad USD High Yield Corporate Bond ETF (USHY), and high-yield dividend equity ETFs, like certain strategies that may offer yields exceeding those of broader dividend ETFs, such as the Schwab US Dividend Equity ETF (SCHD).
While the allure of higher income can be strong, these segments carry amplified risks in a decelerating economic environment.
With economic data, such as last week’s Leading Economic Index, pointing to a slowdown and possibly a recession by 2026, it’s an opportune moment for advisors and investors to reassess the risks behind high-yield ETFs.
Junk Bond ETFs: Elevated Default Risks in a Downturn
High-yield corporate (junk) bond ETFs like USHY, often tracking debt rated below investment grade, offer higher yields to compensate investors for their increased credit risk. However, this inherent risk becomes significantly magnified in a slowing economy.
As economic growth stagnates or contracts, companies with weaker financial footing face greater difficulty in generating sufficient cash flow to service their debt obligations. This translates directly to a rising default risk within the high-yield bond market. Should defaults increase, the value of the underlying bonds held by ETFs like USHY would decline, leading to capital losses for investors.
Furthermore, the price dynamics of high-yield bond ETFs differ significantly from higher-quality fixed income during economic downturns. In recessionary periods, investors typically flock to the safety and liquidity of higher credit quality bonds, such as U.S. Treasurys. This increased demand drives Treasury prices up and yields down, benefitting funds like the iShares 20+ Year Treasury Bond ETF (TLT).
Conversely, high-yield bond ETFs often experience price declines during such times as investors become risk-averse and concerns about defaults escalate, leading to widening credit spreads (the difference in yield between high-yield bonds and safer government bonds).
Top 5 High Yield (Junk) Bond ETFs by AUM as of July 22
Ticker | Fund | Expense Ratio | AUM | Yield |
0.08% | $24.9B | 7% | ||
0.49% | $17.3B | 6.5% | ||
0.4% | $10.4B | 5.3% | ||
0.05% | $8.9B | 7.2% | ||
0.7% | $8.1B | 6.7% |
Source: etf.com & FactSet Data
High-Yield Dividend ETFs: Stability Isn’t Guaranteed
On the equity side, the pursuit of high dividend yields can also lead to increased risk in a slowing economy.
While dividend-focused ETFs like the Vanguard Dividend Appreciation ETF (VIG) prioritize companies with a history of consistent dividend growth and strong financial health, certain "high-yield" dividend ETFs like the iShares Select Dividend ETF (DVY) may also hold companies with high payout ratios but less stable earnings. These companies, while currently offering attractive yields, are more susceptible to dividend cuts when economic conditions deteriorate.
In a slower economy, corporate earnings often come under pressure. Companies facing reduced demand and tighter margins may be forced to reduce or eliminate their dividend payouts to conserve cash. This can lead to significant price declines in the high-dividend-paying stocks and the ETFs that hold them.
Unlike companies with more sustainable dividend policies (like those favored by SCHD or VIG), the high yields in riskier dividend ETFs may not be sustainable through an economic downturn, leaving investors with both reduced income and potential capital losses.
Related: Dividend ETFs: VIG vs. SCHD Comparison Guide
Top 5 High Dividend Yield ETFs by AUM as of July 22
Ticker | Fund | Expense Ratio | AUM | Yield |
0.06% | $70.3B | 3.8% | ||
0.06% | $61.8B | 2.6% | ||
0.35% | $20.3B | 2.5% | ||
0.38% | $19.9B | 4% | ||
0.17% | $11.2B | 4.2% |
Source: etf.com & FactSet Data
Tactful Positioning & Risk Management
Both high-yield bond and high-dividend equity ETFs can certainly enhance income but, in a recession or sharper slowdown, their downsides surface quickly. That’s why it's important for investors to:
- Rotate tactically: When signs point toward slower growth (like yield curve inversion or recession indicators), reducing allocations to high-yield bond ETFs can mitigate risk.
- Diversify across quality: Pair high-yield exposure with core bond funds and stable dividend ETFs to balance volatility and income goals.
- Adjust positioning into 2026: As elevated risks unfold, consider reducing overweight to high yield and rebalancing toward investment-grade or Treasury-focused allocations.
Related: Morningstar: The Best High-Dividend ETFs for Passive Income
Final Take
High-yield strategies, whether in bonds or dividends, can shine in a healthy economy, but they are vulnerable when growth stumbles. With recession risk rising, it's crucial to review weightings and maintain defensive ballast in portfolios. For advisors and investors, now is the time to ensure high-yield allocations remain opportunistic, not accidental.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Investing in ETFs involves risks, and investors should carefully consider their investment objectives and risk tolerance before making any investment decisions.
At the time of publication, Kent Thune did not hold a position in any of the aforementioned securities.
