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Rivals in, but Vanguard won't offer junk-bond ETFs

Feb 20, 2013 @ 10:11 am

By Jason Kephart

ETF firms
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Don't hold your breath for a high-yield-bond exchange-traded fund from Vanguard.

High-yield-bond ETFs from the two largest ETF companies, BlackRock Inc.'s iShares and State Street Global Advisors, have seen their assets more than quintuple to $27 billion combined since 2009, thanks to $24 billion in inflows, according to IndexUniverse LLC.

The Vanguard Group Inc., the third-largest ETF provider, is staying away from offering such a product, not because of any particular view on its outlook or its benefit to a portfolio but because of the way high-yield-bond ETFs trade.

High-yield bonds are generally less liquid than their investment-grade counterparts. That lack of liquidity forces the share price of high-yield-bond ETFs to drift from their net asset value and trade at a premium when money is coming in or at a discount when investors are pulling out.

“Those swings hurt the average investor if they're following the crowd,” said Ken Volpert, head of taxable bonds at Vanguard.

The $15 billion iShares iBoxx High Yield Corporate Bond ETF (HYG) has been the most popular high-yield-bond ETF since 2009

It attracted $13 billion in net inflows through the end of last month, according to IndexUniverse.

As a result of those inflows, the ETF has traded at an average premium of 93 basis points since the beginning of 2009, according to Morningstar Inc.

That means investors were paying an average of nearly $1.01 for every $1 worth of the ETF's NAV over that time.

In the most extreme times of buying and selling, the ETF's share price has varied as far as 2.88% north of its NAV and 1.76% south, according to Morningstar.

If an investor had sold his or her shares during that most extreme selling period in 2009, he or she would have gotten less than 99 cents returned for each $1 of the ETF's NAV.

The phenomenon isn't unique to the iShares ETF. The $12 billion SPDR Barclays High Yield Bond ETF (JNK) has swung as wide as a 3.98% premium and a 0.73% discount.

The consistent premiums and discounts mean that financial advisers have to be much more careful about buying and selling, said Lee Munson, principal at Portfolio LLC.

“With junk bonds, you really need to have a plan,” he said.

“I only put in as much as I'm willing to let sit for a while. If you need a quick exit, don't go into a junk bond ETF,” Mr. Munson said.

The premium and discounts actually give advisers an advantage, said Matt Tucker, head of iShares' fixed-income strategy.

“It lets you have better control of your execution,” he said. “You can see where the high-yield market is trading and execute at that price.”

Mr. Volpert agrees that there is a potential to take advantage of the premiums and discounts at which bond ETFs trade, but whether the average investor is capable of making the right calls is another question.

“There's an opportunity to make money if you're on the right side of the trade,” he said. “At this point, we think the average investor is better off in a mutual fund.”

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