VTC - HYBB: A Risk-Return Sweetspot

2023-06-20 08:01:31 ET

Summary

• HYBB is a less risky alternative to other junk bond ETFs like JNK, investing primarily in higher-tier BB rated bonds.
• With a 30-day SEC yield of about 7.1%, HYBB offers a higher yield than investment-grade corporate bond ETFs like VTC.
• HYBB is a suitable investment for those who believe in a mild recession and want to take risks in the market while avoiding extreme risks.

iShares BB Rated Corporate Bond ETF ( HYBB ) offers exposure to non-investment grade junk bonds in a unique way. HYBB currently has a 30-day SEC yield of about 7.1%. This ETF provides less risky exposure to junk bonds, giving it a lower yield than other junk bond ETFs like JNK , but also offers a higher yield than investment-grade corporate bond ETFs like VTC . This ETF is for investors like me, looking to add more risk than investment-grade corporate bonds to their portfolio but also aren't bullish on the equity market. For investors in this situation, I rate HYBB ETF a Buy.

Holdings

HYBB holds 890 individual junk bonds. HYBB's top 10 holdings make up a little under 5% of the total AUM, giving HYBB excellent diversification

HYBB holds bonds with a variety of maturities. Most of HYBB's holdings have maturity times of 3-5 years and 5-7 years.

What makes HYBB special is the credit ratings of the bonds held. HYBB invests almost exclusively in bonds with a credit rating of BB. Only just over 6% of its assets are in non-BB bonds.

This means that although HYBB holds non-investment grade bonds, they are the higher tier junk bonds . This limits HYBB's risk, but in return lowers the yield.

HYBB vs. JNK

JNK is a large junk bond ETF with about $8.5B in AUM. Considering HYBB's $238.5M AUM, I think it's fair to say HYBB is neglected by junk bond investors. A big difference between the two is their yields. HYBB's 30-day SEC yield is about 7.1%, whereas JNK's is currently about 8.2%, over a percent higher than HYBB’s. While the higher yield that JNK offers may seem enticing, it may not be worth the added risk. As discussed before, HYBB invests in top-tier junk bonds. JNK has about 75% of its holdings below BB. JNK invests far more in bonds with very low-tier credit ratings. Considering that 75% of JNKs holdings are under BB, is owning something with a 1% higher yield worth it? I don't think so.

I recently wrote an article on JNK where I go more in-depth on why JNK will likely suffer due to bond defaults caused by the coming recession, but I think HYBB is a much better alternative. It should be understood that HYBB does have more default risk than an investment-grade bond ETF, but investing in mainly BB bonds limits the risk to a more acceptable level.

HYBB vs VTC

VTC is Vanguard's total corporate bond market ETF. VTC has a current 30-day SEC yield of about 3.4%. This yield is far lower than HYBB's, but that's because VTC invests in investment-grade bonds so they have less risk. it may come as a surprise to know that almost 50% of VTC's AUM and HYBB's BB bonds have only 2 credit ranking tiers between them.

VTC holds almost 50% of its assets in BBB bonds. The remaining 50% is mostly in A bonds, limiting VTC's risk even more. But that doesn't take away from the fact that VTC holds 50% of its assets in marginally investment-grade bonds. By no means am I saying that VTC is as risky as HYBB. That certainly isn't true, but looking at the risk-to-yield ratio, I think HYBB is worth the risk. HYBB offers about 3.7% more in yield than VTC, meaning that investors who can tolerate the risk get the trade-off of a higher yield.

Who should buy HYBB

If you believe we are headed to a mild recession and want to still take risks in the market, HYBB is for you. During economic turmoil, junk bonds are more likely to default. But obviously, bonds with lower credit ratings are the most susceptible to default risk. This makes HYBB a great choice if you want to avoid the extreme risk of JNK, but also want more risk and a higher yield than VTC. HYBB doesn't just offer a higher yield now but also offers capital appreciation in the future when rates start to get cut, giving it an even better long-term outlook

The risks of HYBB

If you are an investor looking to ride out the coming recession in ultra-safe assets like SGOV or BIL , this ETF isn't for you. Although I am recommending HYBB as a buy for certain investors, there is a serious risk to buying HYBB if this recession isn't mild, as I'm predicting it will be. If the coming recession is severe, all corporate bonds will be much more likely to default, especially non-investment grade bonds, which could really hurt HYBB.

Conclusion

HYBB offers exposure to junk bonds in a less risky way than other junk bond ETFs like JNK. HYBB invests in higher-tier junk bonds, primarily BB bonds. Because HYBB takes on more risk than investment-grade corporate bond ETF, it has a higher yield. If the coming recession is mild, HYBB owners will benefit from the high yields and the coming capital appreciation when rates drop. I rate HYBB a Buy.

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