HYGH - HYGH: Pure-Play On High Yield Credit Spreads
Summary
- The HYGH ETF provides interest rate hedged exposure to high yield bonds.
- It can be thought of as a pure-play on the direction of credit spreads.
- Compared to floating rate senior loan funds like the BKLN ETF, HYGH has superior returns and Sharpe Ratios.
The iShares Interest Rate Hedged High Yield Bond ETF ( HYGH ) provides exposure to an interest-rate hedged portfolio of high yield bonds. The HYGH ETF looks like a viable competitor to traditional senior loan funds like the Invesco Senior Loan ETF ( BKLN ). HYGH has superior historical returns and higher Sharpe Ratios.
Investors should note that the HYGH ETF's distribution yield and total returns are closely tied to the level and direction of high yield credit spreads. When high yield spreads are widening, distributions may be higher, but total returns can actually be negative.
Fund Overview
The iShares Interest Rate Hedged High Yield Bond ETF tracks the returns of an interest-rate hedged high yield bond index. The HYGH ETF is relatively young, with an inception date of May 27, 2014. It charges a net expense ratio of 0.52%, contractually fixed until February 2027 after fee waivers of 0.60% (Figure 1).
Strategy
The HYGH ETF tracks the BlackRock Interest Rate Hedge High Yield Bond Index ("Index"), an index designed to minimize the interest rate risk of a portfolio of U.S.-dollar denominated high yield ("junk") corporate bonds.
The fund achieves its objective by basically owning the iShares iBoxx $ High Yield Corporate Bond ETF ( HYG ) and a portfolio of interest rate swaps to hedge out interest rate exposure.
The main purpose of the HYGH ETF is to allow investors a way to express their views on the creditworthiness of high yield bonds, without the associated interest rate risk of owning the securities outright.
Portfolio Holdings
As mentioned above, the HYGH ETF holds the HYG ETF and a portfolio of interest rate swaps to hedge interest rate risk (Figure 2).
Figure 3 shows the sector allocation of the fund (which is basically a readthrough of the underlying HYG's sector allocation). The largest sector weights are consumer cyclicals (20.3%), communications (17.6%), consumer non-cyclicals (12.8%), energy (11.1%) and capital goods (9.6%).
In terms of credit quality, 49.7% of the fund is invested in BB rated securities and 36.8% is invested in B rated securities (Figure 4).
Overall, the fund's interest rate hedges have neutralized its interest rate exposure, with the fund having an effective duration of only 0.07 years (Figure 5).
Returns
Figure 6 shows the historical returns of the HYGH ETF. Since the fund hedges out interest rate risk, returns on the HYGH ETF can be thought of as earning high yield credit spreads less fund expenses.
Distribution & Yield
The HYGH ETF paid a trailing 12 month distribution of $5.09 / share or 6.0% yield (Figure 7). HYGH's distribution is paid monthly.
Investors should note that the HYGH's distribution tracks high yield credit spreads. For example, in 2020 and 2021 when credit spreads tightened following the COVID pandemic, distributions paid were low. In 2022, when credit spreads widened, distributions paid were increased (Figure 8).
Figure 8 - HYGH distribution vs. HY Credit Spreads vs. annual returns (Author created with distributions from Seeking Alpha, HY Credit Spreads from St. Louis Fed, annual returns from morningstar.com)
Credit Cycle Drives Total Returns
Another point investors should note is that even though interest rate risk has been hedged out for the HYGH fund, it is still susceptible to credit risk. While widening credit spreads drive HYGH's distributions higher, it may actually lead to negative total returns because the portfolio's bond prices would decline with wider credit spreads.
For example, while 2015, 2018, and 2022 were strong 'distribution' years for the HYGH ETF, they were actually negative 'total return' years for the fund (Figure 8 above). Paradoxically, HYGH investors should hope for modest/low distributions from HYGH, as that would be indicative of tightening credit spreads and high total returns, like 2016 and 2019.
HYGH vs. BKLN
Given HYGH has hedged out its interest rate exposure, it essentially trades like high yield credit spreads. Therefore, one good comparison fund for the HYGH ETF would be the Invesco Senior Loan ETF ("BKLN"), which tracks an index of floating rate senior loans. The BKLN ETF has roughly comparable credit quality allocations vs. the HYGH, with 23% in BB-rated and 58% in B-rated securities vs. HYGH's 50% and 37% respectively (Figure 9).
Figure 10 shows a comparison between HYGH and BKLN, using my proprietary scorecard. With the fee waivers until 2027, the HYGH is a cheaper fund vs. BKLN.
Figure 10 - HYGH vs. BKLN (Author created with returns and risk metrics from morningstar.com and fund details and distributions from Seeking Alpha)
The HYGH ETF also has superior historical returns on a 1/3/5Yr time frames. However, the HYGH ETF is more volatile, but its higher returns give the fund a better Sharpe Ratio. BKLN has a smaller maximum 5Yr drawdown.
Finally, comparing their distributions, the HYGH ETF has a higher trailing 12 month yield, but BKLN's yield has been growing faster.
Conclusion
The HYGH ETF provides exposure to an interest-rate hedged portfolio of high yield bonds. Owning the HYGH ETF can be thought of as a bet on the direction of high yield credit spreads.
The HYGH ETF looks like a viable competitor to traditional floating rate senior loan funds like the BKLN ETF. It has superior historical returns and a higher Sharpe Ratio.
Investors should note that the HYGH ETF's distribution yield and total returns are closely tied to the level and direction of credit spreads. When high yield spreads are widening, distributions may be high, but total returns can actually be negative.
For further details see:
HYGH: Pure-Play On High Yield Credit Spreads