Rising rates creating short-term junkies

Rising interest rates have yield-starved investors moving into short-term high-yield-bond funds, and mutual fund companies are planning new…

Rising interest rates have yield-starved investors moving into short-term high-yield-bond funds, and mutual fund companies are planning new products to meet the demand.

Eaton Vance Corp. and Fidelity Investments are the latest mutual fund companies to plan to offer such funds. They both unveiled plans to launch them this month.

Wells Fargo & Co. launched the first short-term high-yield-bond fund, the $1.4 billion Wells Fargo Advantage Short-Term High Yield Bond Fund (STHBX), in 1997, but the most popular short-term high-yield options so far have been exchange-traded funds.

Since May, when interest rates began to climb, investors have shown a clear preference for shorter-term funds in the high-yield space.

“You're getting pretty much all the yield and a lot less of the interest rate risk,” said Louis Kokernak, a principal at Haven Financial Advisors.

The $2.9 billion Pimco 0-5 Year High Yield Corporate Bond ETF (HYS) and the $1.7 billion SPDR Barclays Capital Short Term High Yield Bond ETF (SJNK) have seen inflows of $931 million and $560 million, respectively, since May 1, according to Index-Universe LLC.

LONG-TERM FUNDS LOSE

The two most popular longer-term high-yield-bond ETFs, the iShares iBoxx High Yield Corporate Bond ETF (HYG) and the SPDR Barclays High Yield Bond ETF (JNK) have suffered net outflows of $492 million and $2.29 billion, respectively.

The move turned out to be good for advisers such as Mr. Kokernak, who uses the SPDR short-term ETF.

The SPDR Barclays Capital Short Term High Yield Bond ETF, which has an average maturity of about 3.5 years, lost just under 1% in the second quarter, when rates shot up 100 basis points to 2.5%. Its longer-dated sibling, which has an average maturity of 6.75 years, lost about 2.5% during the quarter.

For the year, the shorter-term ETF is up 2.67%, while the longer-term one is down 0.35%.

One of the big reasons for the outperformance is that even though the durations are shorter, there isn't a big difference in the yield the funds pay out.

The yields on the two SPDR High Yield Bond ETFs are 5% for the short-term one and 6% for the long-term one, for example. The Pimco 0-5 Year High Yield Bond ETF has a yield of 4.7%.

CUSHION AGAINST RATES

Those high yields create a cushion against rising rates, which cause bond prices to drop.

Rates have come back into the spotlight as the possibility that the Federal Reserve Bank will cut back on its asset purchases has become more realistic.

Initial jobless claims dropped to 320,000, the lowest level since October 2007, during the one-week period ended Aug. 16. That caused the 10-year U.S. Treasury note to surge to 2.89% last Friday, its highest level since August 2011.

Even though the short-term junk bond funds will protect against rising interest rates, Mr. Kokernak said it is important to keep in mind that they won't offer extra protection from the other extreme — credit risk.

“If there's a risk of recession, junk bond prices could crater,” he said. “That's true for short-term junk, too.”

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