JNK - HYDB: If You Want Better Junk This Is It

2023-11-16 09:15:22 ET

Summary

• The iShares High Yield Bond Factor ETF seeks to outperform the broader high-yield corporate bond market by focusing on quality and value factors.
• HYDB has performed well compared to other high-yield bond ETFs like HYG and JNK, highlighting the potential benefits of its factor-based investment strategy.
• Investing in HYDB offers advantages such as superior risk-adjusted returns, a lower expense ratio, and monthly dividend distributions, but it also carries credit risk, interest rate risk, and liquidity risk.

I've been critical of junk debt for some time from a buy and hold perspective given where credit spreads are, and maintain my view that this is a risky part of the bond marketplace to play with. Having said that, there's a unique take on high yield bond investing with the iShares High Yield Bond Factor ETF (HYDB). HYDB is an exchange-traded fund that seeks to outperform the broader high-yield corporate bond market by capitalizing on two key factors: quality and value. The fund aims to track the investment results of the BlackRock High Yield Defensive Bond Index, an index composed of U.S. dollar-denominated, high-yield corporate bonds.

The primary objective of the HYDB is to deliver superior risk-adjusted and total returns, compared to the broader high-yield corporate bond market. The fund achieves this by blending two diversifying factors - quality, which seeks to mitigate risk by avoiding riskier securities, and value, which focuses on enhanced returns by favoring undervalued bonds.

When we look at how HYDB has performed relative to HYG, we can clearly see it's working.

Key Holdings of HYDB

The fund's portfolio is composed of a select group of U.S. dollar-denominated, high-yield corporate bonds that pass its rigorous screening process. The top five individual positions held by HYDB include:

1. Carnival Corporation : A leading global cruise company, Carnival Corporation has shown resilience despite the pandemic's impact on the tourism industry. HYDB's investment in Carnival Corporation underscores its focus on quality and value in the context of potential recovery plays.

2. Royal Caribbean Cruises Ltd : Another major player in the global cruise industry, Royal Caribbean Cruises Ltd. has demonstrated strong recovery potential despite the challenges posed by the pandemic.

3. Sirius XM Radio Inc : This American broadcasting company is known for its satellite radio services. Its strong subscriber base and diverse content offerings make it a valuable addition to HYDB's portfolio.

4. Ford Motor Credit Company LLC : As the financial services arm of the Ford Motor Company, this entity offers a variety of automotive financing products to Ford dealers and customers. Its strong industry standing and stable returns contribute to its value within HYDB's portfolio.

5. CCO Holdings LLC : As a subsidiary of Charter Communications, one of the largest cable operators in the U.S., CCO Holdings LLC offers promising returns potential, bolstered by the robust demand for broadband services.

These holdings, among others in HYDB's portfolio, are subject to change based on the fund's ongoing assessment of quality and value.

Sector Composition and Weightings

The sector composition of HYDB reflects its strategic focus on quality and value. The fund maintains a balanced portfolio across different sectors, with a particular emphasis on sectors that offer a strong blend of risk and return potential. Consumer Cyclicals and Energy make up the bulk of the portfolio. The Energy allocation is a plus as the sector has tons of free cash flow making their bonds likely more secure than similar rated bonds in other sectors.

Comparison with Peer ETFs

The two most popular high yield bond ETFs are the iShares iBoxx $ High Yield Corporate Bond ETF ( HYG ) and the SPDR Bloomberg High Yield Bond ETF ( JNK ). While these funds offer broad exposure to the high-yield bond market, HYDB differentiates itself by focusing on quality and value. This approach has resulted in HYDB outperforming both HYG and JNK over various time horizons, underscoring the potential benefits of its factor-based investment strategy.

The Pros and Cons of Investing in HYDB

Investing in HYDB offers several notable advantages:

1. Superior Risk-Adjusted Returns : By focusing on quality and value, HYDB aims to deliver superior risk-adjusted returns relative to the broader high-yield bond market. This approach can potentially enhance portfolio returns while mitigating risk.

2. Lower Expense Ratio : With an expense ratio of just 0.35%, HYDB is a cost-effective option for investors seeking exposure to the high-yield bond market.

3. Monthly Dividend Distribution : HYDB follows a monthly dividend distribution policy, allowing investors to compound their returns effectively.

4. Quality and Value Focus : HYDB's focus on quality and value can potentially lead to better performance during various market conditions.

However, it's important to note some potential downsides:

1. Credit Risk : HYDB, like all high-yield bond ETFs, is exposed to credit risk. This represents the risk that the issuer of a bond will default on its obligation to pay interest and principal. While HYDB's focus on quality can help mitigate this risk, it cannot eliminate it entirely.

2. Interest Rate Risk : HYDB, given its bond holdings, is also exposed to interest rate risk. This is the risk that the value of bonds will decrease when interest rates rise.

3. Liquidity Risk : Compared to larger, more liquid funds like HYG and JNK, HYDB is relatively smaller and less liquid. This could potentially impact the ability to buy or sell shares quickly and at desired prices.

Conclusion: The Investment Case for HYDB

The iShares High Yield Bond Factor ETF is a good fund in a part of the bond marketplace I consider still to be high risk. Its focus on quality and value, coupled with a lower expense ratio and monthly dividend distribution policy, makes it an attractive option for investors. I'd rather consider this for buy and hold investors than HYG or JNK.

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