The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) is turning 10 years old this week.
Looking back a decade, few then would’ve thought investors would be able to trade more than 1,000 high-yield bonds at a penny spread on a stock exchange. HYG was a massive feat of innovation—one of many ETFs that truly democratized access to difficult-to-reach pockets of the market.
To mark the anniversary, we caught up with Steve Laipply, product strategist for BlackRock's Model-Based Fixed Income Portfolio Management Group, to talk about this ETF, the innovation it represented and the misconceptions that still surround it. Here are some key takeaways from our chat:
Timing Of The Launch
HYG came to market in early 2007, on the eve of the big financial crisis, if you will. It was a turbulent time for the market, and one might think not the best time to be rolling out the first high-yield bond ETF.
But iShares had already some experience with fixed-income ETFs and a good understanding of what to expect, Laipply says.
“The financial crisis actually offered us our first inkling of how HYG—and for that matter, LQD [iShares iBoxx $ Investment Grade Corporate Bond ETF]—could be very valuable tools for investors to both observe the market as well as manage risk,” he noted.
“That time period was, in our view, when investors woke up to the idea that even if the bond market was not trading in its full capacity, these products were observable on exchange and they could trade them, even through the most difficult periods of the crisis,” Laipply added.
Perennially Strong Liquidity
HYG never seemed to have a liquidity problem. The fund, which today trades on average more than $1 billion every day, does so at a penny spread. That’s an attribute of the structure itself, Laipply says.
“There are a lot of misconceptions surrounding ETFs. Oftentimes, there's a narrative that during periods of market stress, you can have forced inflows or outflows, and that's simply not the case,” he said.
According to him, even in periods of market stress in the bond market, investors will still be able to trade HYG on exchange, away from the bond market itself. “It's a layer of additional liquidity that exists that's not present in other instruments.”
Most of HYG's trading happens on the stock exchange, but the underlying doesn't have to be actually traded in the bond market.
“We've observed during periods of market stress that the amount that's traded on exchange relative to the bond market through creation/redemption process actually increases,” said Laipply.
If you look back, for example, to December 2015, when there was a fairly pronounced risk-off market in high yield, HYG traded more than $30 billion for the entire month. At the same time, the amount of net redemptions was around $1.5 billion, so the ratio of volume that cleared on exchange away from the underlying market was roughly 20-to-1, he notes.
Trading Cost Benefits
Trading HYG is cheaper than trading an actual high-yield bond. According to iShares data, you get a 1 basis point bid/ask for the ETF versus 50 basis points for individual bonds. Laipply says that’s due to several reasons.
In his words: “in order of progression, you have a portfolio bond and a portfolio itself will trade differently than individual bonds. You then add to that the idea of transparency and a rules-based exposure, so the bonds enter and leave HYG based on specified rules according to the index that it tracks. You then have the ability to see all of the holdings in HYG daily. Those attributes alone would allow for greater comfort around trading, and therefore compress the bid/ask spreads.”
Finally, you also have different places to trade: the exchange, which is the primary venue; and the over-the-counter markets; or creation/redemption, which allows the portfolio and exchange to stay anchored to the value of the underlying bond.
All of these factors allow for this huge compression in trading cost.
Who Actually Owns HYG
Relative to the size of the high-yield bond market, HYG represents only about 2% market share despite it being a $19 billion fund. That may seem small, but investor adoption of this strategy—and others like it—is on the rise as more and more people learn how to use ETFs for long exposure, hedging or for tactical reasons.
Today about 50% of HYG assets are retail money, according to iShares data, and the other 50% includes the likes of asset managers, pensions and insurance companies, among others. That investor profile has evolved over time.
“Initially, it was fair to characterize HYG as more of a retail product when it first launched,” Laipply said. “But over time, as it's grown in both size and liquidity, investors of all sizes have started to find real utility in this strategy.”
Die-Hard Misconceptions About HYG
There are many who believe that somehow having HYG trade on an exchange creates potential stress on the market. ETFs often get a bad reputation for that sort of thing, according to Laipply. But that’s a “misconception.”
“If anything, giving the exposure the ability to trade in two different places effectively allows for the most efficient clearing of risk,” he said.
Outlook For High-Yield Bonds
The latest BlackRock market commentary said that credit spreads have tightened a lot, and there could be more downside risk at current levels than potential for price appreciation.
To Laipply, the core message is that the firm is now “neutral” on high-yield bonds: “But that doesn't mean negative. It means that we think high yield as an asset class serves a very vital role for income generation in the portfolio.”
As he put it, you’d own high-yield bonds for one of two reasons: for attractive value following a “cheapening in the market,” or as an income-generating asset class. Right now, Laipply says the high-yield bond market is offering more income than value.
Chart courtesy of StockCharts.com
Contact Cinthia Murphy at [email protected]