Under The Hood: An Unheralded Junk Play

The junk bond ETF space is dominated by two ETFs: The iShares iBoxx $ High Yield Corporate Bond ETF HYG and the the SPDR Barclays Capital High Yield Bond ETF JNK. Combined, those two ETFs had almost $25 billion in assets under management as of the close of markets on June 21. With investors' thirst for yield increasing, the dominance of HYG and JNK in the high-yield bond space has not served as a deterrent to ETF sponsors looking to introduce new junk bond funds. Rather, the success of those ETFs has prompted a spate of new high-yield bond fund introductions this year. Among the rookie crop of junk bond ETFs is the iShares B - Ca Rated Corporate Bond Fund QLTC, which debuted in late April. Indicating that investor interest in junk bond funds is still robust, the iShares B - Ca Rated Corporate Bond Fund joins a decent-sized line of new high-yield funds that are doing well in terms of attracting AUM. Just two months on the market and QLTC has nearly $10 million in AUM. QLTC, which charges an annual expense ratio of 0.55%, is not entirely true to its name as roughly a third of the fund's holdings are rated higher than B by Standard & Poor's. In fact, QLTC's top holding is rated AA+ by S&P. That said, the rest of the fund is rated BB+, S&P's highest non-investment grade rating, or lower. S&P ratings of B, B+ and B- imply a highly speculative issue and there is where over 61 percent of QLTC's holdings are classified. Drop into the CCC+, CCC ares or lower, and investors are looking at issues that carry substantial risks and are considered extremely speculative. About 18% of QLTC's holdings are rated CCC+, CCC or CCC-. QLTC has a weighted average maturity of 5.22 years, which is slightly above HYG's 4.92 years, but below JNK's 6.87 years. The new iShares offering, which is currently home to 125 issues, features an effective duration of 3.96 and a weighted average coupon of 8.15%. Communications, consumer non-cyclical, consumer cyclical and technology are the sectors featured most prominently in QLCT, combining for about 60% of the fund's weight. The allure of QLTC, as is the case with any high-yield bond fund, is that high yield. QLTC obliges with a 30-day SEC yield of 7.71 percent and a distribution yield of 6.88%. That gives QLTC a 30-day SEC yield that is nearly 50 basis points higher than JNK's and a distribution that is 43 basis points below HYG's. Then again, investors might want to focus more on yield to maturity. Yield to maturity is the discount rate that equates the present value of a bond's cash flows with its market price, according to iShares. As Peter Tchir founder of TF Market Advisors recently said in an interview with Benzinga "I would like to see regulators focus on making sure yield to call or yield to maturity is done accurately and highlighted, because investors seem to focus on the dividend yield, but in reality, expected return should be based on yield to call rather than dividend yield as the pull to par effect is real for an ETF holder." QLTC has a yield to maturity of 7.82%, slight above JNK's, but nearly 100 basis points of above HYG's. Tracking error is another issue to consider with junk bond ETFs. Given the decline in liquidity in the high-yield debt market, it has become harder for fund managers to own all of an index's securities. JNK has a tracking error of 0.38%according to XTF data. Meanwhile, iShares data indicate QLTC's tracking error has been just 0.05%. QLTC's short lifespan makes it difficult to comment on whether this is a "good" or "bad" ETF, but the bottom line is investors' willingness to incur risk in search of yield will determine this fund's fate. For more on junk bond ETFs, click here.