Finding Value In A New High-Yield ETF

These are trying times for high-yield corporate bond investors. The widely followed Markit iBoxx USD Liquid High Yield Index is modestly higher on a year-to-date basis, but a massive chunk of the shares outstanding in the largest junk bond exchange traded fund are sold short as traders fret about the impact of higher interest rates on high-yield corporate debt.

FlexShares, the ETF unit of Northern Trust Corp. NTRS, added to its lineup of smart beta bond funds Wednesday with the debut of the FlexShares High Yield Value-Scored Bond Index Fund HYGV.

What Happened

The new ETF tracks the FlexShares High Yield Value-Scored Bond Index Fund. That benchmark “utilizes Northern Trust’s proprietary credit scoring model to maximize factor inputs for value while screening for quality and liquidity risk,” according to a statement. “The fundamentals of the bond issuers are then evaluated against current market conditions, and the lowest quality issuers are removed from the index.”

Traditional bond indexes, including many used by ETFs, are cap-weighted, meaning issue size determines the bonds' weights throughout the index.

Why It's Important

HYGV uses a multistep process that starts with a value focus. In maximizing exposure to value, the fund focuses on bonds' valuation, spread analysis and issuer solvency. The second step is evaluating issuers' credit scores, which includes inputs such as management efficiency, solvency and profitability.

Next, the fund assesses issuer liquidity using age, time to maturity and debt outstanding as the inputs. The final step is to optimize those factors and inputs.

HYGV debuted with 257 holdings and a weighted average effective duration of 4.16 yeas. Duration gauges a bond's sensitivity to changes in interest rates. None of the new ETF's holdings exceed weights of 1.11 percent, and the top 10 holdings combine for just 9.68 percent of HYGV's weight.

What's Next

Nearly 93 percent of HYGV's holdings have maturities of less than 10 years. The new ETF charges 0.37 percent per year, or $37 on a $10,000 investment.

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