Passive Approach Can Serve Investors Well With Junk Bonds

The iShares iBoxx $ High Yid Corp Bond (ETF) (NYSE:HYG) and the SPDR Barclays Capital High Yield Bnd ETF (NYSE:JNK) are the two largest high-yield corporate bond exchange-traded funds by assets and are currently home to nearly $29 billion in combined assets under management.

While that is an impressive number, it is a mere fraction of the total U.S. junk bond market, indicating that many investors prefer actively managed mutual funds for high-yield bond exposure to passively managed ETF equivalents. Data suggest such preferences are not always rewarded.

Success And The Numbers

The data is relatively discouraging for actively managed long-term investment grade (16 percent), intermediate-term investment-grade (17 percent) and high yield (25 percent) funds and their ability to duplicate success. However, the numbers are more encouraging for the persistence of those strong performing active emerging market debt (46 percent) and short-term investment-grade (37 percent) funds, said S&P Capital IQ in a note out Tuesday.

Related Link: Stick With Passive Mid-, Small-Cap ETFs Over Active Funds

That data from S&P Capital IQ comes on the heels of a report by the research firm out Monday highlighting some of the shortcomings of actively managed mid- and small-cap mutual funds compared to their lower fee, passive ETF rivals.

Mid-, Small-Caps Versus Passive ETF Rivals

HYG, the largest junk bond ETF, rose 5.76 percent in 2013, less than the 6.85 percent mutual fund average. But, passively managed HYG's 1.91 percent gain in 2014 and 5.01 percent loss in 2015 were better than the 1.36 percent and 4.07 percent respective positive and negative returns for active funds. HYG has $17 billion in assets, said S&P Capital IQ.

The PowerShares High Yield Corporate Bond Portfolio (NYSE:PHB) is nearly 9 years old, making it one of the oldest smart beta bond ETFs on the market. Like HYG, PHB is cost-effective and stacks up well against active equivalents in terms of past performance.

Both ETFs have a 0.50 percent expense ratio, much lower than the 1.09 percent for the Lipper high yield mutual fund peer group. While we don't think investors should make fund decisions based solely on past performance success, only 42 percent outperformed HYG's 4.17 percent three-year annualized total return through August 17 and only 16 percent were ahead of PHB's 5.02 percent, added S&P Capital IQ.

As it should be, credit quality is an issue to consider with active and passive high-yield funds. PHB holds no debt rated below B, but as S&P Capital IQ notes, the average active junk bond allocates 10 percent of its weight to bonds rated below B.

The research firm has Overweight ratings on HYG and PHB.

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