High-Yield ETF Set To Follow Index Changes

July 06, 2009

High-flying junk bonds are becoming a popular option for ETF investors. But the biggest of the lot is undergoing a sort of metamorphosis.

 

A popular benchmark tracking high-yield bonds is being tweaked. The result is that the biggest exchange-traded fund by assets, the iShares iBoxx High Yield Corporate Bond ETF (NYSEArca: HYG), should become more diversified and a bit more liquid.

The changes came on June 30 and involved underlying methodologies of the Markit iBoxx Liquid High Yield Index. The index changes come as many developments have occurred in the high-yield bond market since the index’s inception. According to Markit, the high-yield market has doubled in the past 10 years. Such increased size has given the so-called “junk” bond market a different profile and breadth, says the index provider.

In the old process, the index equal-weighted 50 high-yield issues limited to and within certain sectors. Under the new rules, 200 liquid bond issues will be included in the mix.

Tweaking For Diversity

High-yield bonds are issued by highly leveraged companies or companies in distress. Both situations make the bond holder demand a much higher yield and total return for the risks of default. Since the bonds are issued by such companies, higher-than-average volatility can be expected.

The chart below shows the risk and return characteristics of the iBoxx Liquid High Yield Index against two other common benchmarks over the last five years.

 

Source: Morningstar (7/1/2009)

 

Historically, the yield of this subinvestment-grade index has been significant. Taking a look at the year-over-year difference in total return and price return, we find that regarding calendar-year yields from 1999 through 2008, the iBoxx Liquid High Yield Index has yielded on average 6.24%, whereas the more popular Barclays Capital U.S. Aggregate Bond Index—which includes Treasuries, mortgage-backed bonds and investment-grade corporate bonds—has yielded 5.17% over the same period.

The iBoxx index during 2008 had a yield of 11.56%, whereas the Barclays Capital U.S. Aggregate gave investors a yield of 4.86%. Of course, iShares has another ETF (NYSE: AGG) that tracks the Barclays Capital U.S. Aggregate Bond Index, which has shown similar yield performance.

A Deeper, Broader Benchmark

The Markit iBoxx Liquid High Yield Index began implementing new rules and methodologies during the index’s June 30 rebalance. That process will continue over the next six months, leading to a gradual transition from the old index rules to the updated version. Besides more holdings, the new index will wind up with more diversity among sectors.

Barclays Global Investors, which runs the iShares family, has said that it will continue to use the index for their high-yield ETF, commenting that they intend to manage the fund to keep cost, tax consequences and turnover low.

 

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