High-Yield Bond ETFs May Replace Stocks for Some Investors

High-Yield Bond ETFs May Replace Stocks for Some Investors

Advisors have an opportunity now to lock in much higher income for clients than a couple of years ago.

Reviewed by: etf.com Staff
Edited by: Mark Nacinovich

High-yield bonds instead of stocks

That may not be the first thing investment advisors think of when setting a portfolio strategy. But a unique set of market circumstances has put the asset class also known as junk bonds on the menu. 

The equity market’s ups and downs over the past two-and-a-half years have produced a net result close to zero for the average stock. That can change, but higher interest rates, geopolitical concerns, unemployment ticking up and tentative consumer demand could limit stock returns for a while longer.  

The bond market has suddenly done something it hasn’t done during most investors’ lifetimes: make headlines for their potential future return expectations. That makes sense when considering advisors can now lock in income payments for clients that are five to 10 times what they were a couple of years ago.  

Tighter Spreads 

But maybe, to paraphrase a very old orange juice commercial, “bonds are not just for income anymore” (see “Anita Bryant” for reference). The market is very focused on U.S. Treasury yields, but bonds with lower ratings have higher yields. Specifically, the spread on BB-rated bonds, which tend to dominate high-yield ETFs, sit around 2.5 percentage points above comparable Treasuries. That’s down from a peak of 4.2 percentage points last year and close to the lowest level of the past 18 months.  

Those tighter spreads may be signaling a higher level of comfort from investors toward high-yield bonds. There is a risk of a wave of corporate refinancings next year and the following year, which would put a lot of pressure on some lower-quality companies, because their debt costs would skyrocket compared with a few years ago.  

High-Yield Opportunities 

But not all high-yield issuers are alike, and that combination of the higher income level, plus the tendency for high yield to act like a milder form of equity investing when rates are not accelerating higher, may translate into an opportunity in the foreseeable future. High-yield ETFs are showing signs of that. 

The iShares iBoxx USD High Yield Corporate Bond ETF (HYG) is a $11 billion in assets behemoth that is one of a few very large high yield exchange-traded funds that typically roll of the tongues of advisors when scouting this asset class. While it is a good proxy for how high yield is doing in general, the particular circumstances here favor ETFs that go beyond a broad index of bonds rated BB or below. 

Two that match that description are the $1.25 billion iShares Fallen Angels Bond ETF (FALN) and the $2.33 billion VanEck Fallen Angel High Yield Bond ETF (ANGL). This pair of funds has performed very similarly over the years, and they have both far exceeded the returns of HYG and other large, index-based high-yield ETFs.  

By putting them side by side using etf.com's ETF comparison tool, we see a similar set of top holdings, though each fund is tied to a different index which is designed to identify “fallen angel” bond issuers. These contain bonds that were originally investment grade (BBB rating or higher) but were later downgraded to BB.  

Upsides to High-Yield ETFs 

Some companies get downgraded as the first step toward eventual doom, and there’s always the risk that these indexes end up victim to a wholesale credit market “event” that sinks the entire asset class. We saw that briefly in early 2020, as well as during the 2008 global financial crisis. But barring such an event, these ETFs offer potentially strong dividend yield plus price appreciation as bond rates moderate and eventually dip.  

Bonds as a total return vehicle are an increasingly popular topic now. And while Treasury ETFs may deliver on that, bonds issued by many of the same stocks that could be recovery candidates in a calmer corporate environment are worthy of careful attention as well. 

Rob Isbitts' Wall Street career spans 5 decades and multiple roles, all dedicated to providing clarity to investors by busting classic myths and providing uncommon perspective. He did so as a fiduciary investment advisor, Chief Investment Officer and fund manager for 27 years before selling his practice in 2020. His efforts now focus exclusively on investment research, education and multimedia. He started ETFYourself and SungardenInvestment to provide straightforward commentary and access to his investment intellectual property for portfolio construction, stocks and ETFs. Originally from New Jersey, Rob and his wife Dana have 3 adult children and have lived in Weston, Florida for more than 25 years.