ETF Investors Step Up Their Short Game in Junk Bonds

wsj_printCourtesy of Chris Dietrich, WSJ

After last month’s bond market selloff, many investors are hunting for strategies that can still provide high yields but won’t get hurt by rising interest rates.

Increasingly, they are turning to exchange-traded funds focused on short-term junk bonds, which promise those investors just what they are looking for.

Pacific Investment Management Co.’s Pimco 0-5 Year High Yield Corporate Bond ETF soaked up $602 million since the start of May, just as rates started to tick higher, according to IndexUniverse. The SPDR Barclays Short Term High Yield Bond ETF took in $318 million.

At the same time, investors are heading for the exits in longer-term high-yield bond funds.

The iShares iBoxx $ High Yield Corporate Bond ETF saw outflows of $1.4 billion since May. State Street Global Advisors’ SPDR Barclays High Yield Junk Bond ETF lost $1.8 billion.

Shorter-term ETFs have proved the better option during the latest bout of market duress. Both styles of junk-bond ETFs lost ground last quarter, but the short-term variety’s declines are less severe.

The Pimco 0-5 Year High Yield Corporate Bond ETF and the SPDR Short Term High Yield ETF lost less than 1%, including coupons dividends, in the second quarter, according to Morningstar. The iShares and State Street longer-duration funds, meanwhile, declined more than 2%.

And so far in 2013, the short-term funds returned more than 1%, while their counterparts are in the red.

“Shorter-term junk bonds are lower volatility, so in a downdraft there’s a lot less downside than regular junk bonds,” said Chun Wang, co-portfolio manager at Leuthold Weeden Capital Management, an investment manager based in Minneapolis.

Wang says his firm began selling its longer-term junk-bond ETFs and buying the Pimco short-term junk bond ETF late last year.

Regular high-yield bond ETFs, which hold long-term debt, were virtually unstoppable in the early part of this year with the Federal Reserve pinning down interest rates and buying bonds on the open market in order to spur the economy.

The iShares iBoxx $ High Yield Corporate Bond ETF posted gains for 11 straight months through April, according to Morningstar.

But junk-bond ETFs fell hard when Fed Chairman Ben Bernanke said the Fed could begin to pull back on its bond buying later this year, sending the yield on benchmark 10-year Treasury bonds up one full percentage point in two months.

Shorter-term bonds mature sooner than those in the traditional ETFs, making them less susceptible to losses from rising rates. They also offer less in the way of yield.

The SPDR Short Term High Yield Bond yields 6.1% and offers a market-weighted average debt maturity of 3.5 years. That compares with a yield of 6.5% and an average maturity of nearly seven years for the bigger SPDR High Yield Bond ETF, according to the ETF issuer’s website.

“We see an increasingly good chance of the 10-year rising another [percentage point] over the next year or so, and [if that happens] you’d likely be better in shorter-term, lower yielding bonds,” says Lucas Turton, chief investment officer of Boston’s Windham Capital Management, which oversees more than $1 billion in ETF assets.

Turton says his firm started selling its positions in bigger, more widely traded high-yield bond ETFs and buying ETFs with shorter duration late last year.   For the remainder of the WSJ article, please click here