Short post this morning.
Either they were keeping it a secret or I just missed it but PowerShares just issued a high yield bond ETF under ticker PHB.
The fund holds fifty bonds with the largest weighted at just 2.36%. While junk bonds sometimes instill fear, only about 1% of junk bonds default. The realistic risk is one of more volatility than you might want in a fixed income product.
The average coupon is 7.95% and the average yield to worst is 8.35%. The fee is 0.50% which might seem high but it is the same as the iShares high yield fund which is ticker HYG.
We have had a lot of fixed income and commodity products come lately which I think is a great development and the trend in this direction will continue.
I am not sure this should be looked at as a way to necessarily get higher returns but I think it is realistic to think that, if used properly, these new tools can help smooth out the ride which is a concept I write about often and is coming to be more and more important--to me anyway.
As these disparate asset classes first become available and then as choice comes to the market in these asset classes it creates the opportunity to capture the real diversification that people like David Swensen are able to achieve.
An obvious (hopefully) caveat is that new products also invite the chance for misuse and/or over use. As is always the case there is no hurry to be the first one in the pool.
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19 comments:
Roger, please explain your statement "only about 1% of junk bonds default".
According to Moody's idealized default rates (which corrects for withdrawals and prepayments), the default rate of a Caa rated bond over a 10 year horizon is 65%. (Rating factor for a 10 year horizon is 6500, corresponding to a default rate of 65%.)
The rating factor assigned to a Ba1 bond (first notch below investment grade, which is the threshold for what constitutes "junk" or "speculative grade") over a ten year horizon is 940, corresponding to a 9.4% chance of default within that same time frame.
You are doing your readers a disservice to represent a "1% default rate" to bonds rated below investment grade, unless you are referring to the likelihood of default over a much much shorter time frame. (For example, the default rate of the Ba1 rated bond over a 1 year horizon is 0.87%).
All of this information is available on Moodys.com if you are interested in following up. Search "default studies" and you should come upon several very thorough publications that discuss probability of default (and severity of loss, given default).
Rick
My understanding is that over long periods of time, the default rate is about 1% give or take. So perhaps the 0.87% figure is the stat I have heard before.
65% seems crazy high from an intuitive standpoint.
If I am referring to a statistic incorrectly, I apologize but the 65% is new to me.
I can't get my socks going up and down in excitement over the high yield ETFs until I see lower expenses, proff positive of a low churning rate and the weighting of sectors within the ETFs that indicate true diversification.
It would be nice to see a high yield ETF explore international securities as well as the U.S., again at a low cost without churned portfolios.I like the idea of higher yields plus the possibility of currency appreciation. Since high yield ETFs are a speculation already, why not throw currency in the mix?
T there is the one emerging market sovereign debt etf.
it is a good bet that a corporate one is on a drawing board somewhere and so may come.
Although I have never looked I wonder if there might be a trust of some sort traded in the UK that is accessible in the US, similar structure perhaps at the Vietnam fund I own?
Moody's B rated corporate bonds have a Average Default Rate Within One Year of Rating (1970-2001)
of..............
6.53%
There are different quality of junk bond funds: from truly junk to high quality (e.g., Vanguard's). Which quality junk is this ETF.
average credit quality per the PowerShares site is B+/B1
Roger:
Could you have some comparative analysis between ADRE and newly traded BKF(BRIC iShares with 0.75 ER) when you have chance? Thanks
I don't find a BKF. THere is BIK from statestreet.
BIK is 40% china and ADRE, which is a client and personal holding, is a little over 7% China.
Both have similar weights in Brazil.
BIK, being narrower, offers more risk and probably more potential too.
If China ever blows up worse than the other EM markets BIK would obviously lag.
I doubt they would be much different most of the time but every now and then yes. BIK is new so maybe the difference turns out to be more than I think.
For people not looking to do stock picking I would guess broader would be the more comfortable choice but that is a matter of personal preference.
Roger,
I am happy to send you the Moody's pdf "Corporate Default and Recovery Rates 1920-2006" (updated June 2007) if you provide me an email.
Your "1%" rate is (guessing) most likely a "jump to default" (or "migration to default") probability within 1 year for Ba1 rated corporate bonds. (See Exhibit 13 of the referenced Study.) (See also Exhibit 21: describing the historical average proportion of "year of issuance" defaults for Ba1 rated bonds 1.01%)
However, for an investor who is considering buying and holding a speculative grade (high yield) bond, the relavant statistic is the "survival" rate (or 100%- the cumulative probability of a speculative grade rated (at issuance) bond defaulting within the time horizon in question. According to Moody's, the Issuer-weighted cumulative probability of defaulting for speculative grade bond AND LOAN issuers, over a 10 year horizon is, as reported in Exhibit 24 the referenced study, 31.4%. (Note this includes corporate Loan issuers, which historically have shown a lower probability of default, given the ability of lenders to require rehabilitative and protective covenants, including amortizations.)
Obviously, this "average" blends together the results from different cohorts. It is worth the readers' efforts to review the data for relevant periods (applicable cohorts) in the economic cycle.
The takeaway: 1% may correspond to the probability that any given speculative grade bond will default within a year of issuance, but for a buy and hold investor, speculative grade issuances will (if past history is the guide) default during their tenor with a much much higher probability.
Rick
Rick, thank you for bring all this to my attention. I had heard the 1% number many times and never explored it further which I should have.
Thanks again.
A fund that has been touted as being a good alternative to a MM fund because of it's 6.5% yield is Fidelity's FFRHX which happens to be a junk bond fund.
This fund held it's NAV pretty steady for a good while but dropped about 5% in a heartbeat in August of this year. Note the chart:
http://tinyurl.com/2g5r7x
Here is a Vanguard forum where some fellow almost got burnt getting into this fund in June of this year:
http://tinyurl.com/yuu3oy
I had been tracking this fund for a while and bought in at 9.60 after August and it went up to 9.77. I will be selling and saying a long goodbye to it in early December (it has a 60 day penalty). And BTW, it's down again today to 9.64. It has recently been dropping a penny about every other day
I probably know more about brain surgery than I know about bonds, especially junk bonds. But something is telling me that in this financial environment junk bonds is nowhere to be.
JackS
RE:BKF
When I looked at the iShares site it either wasn't there or i missed it.
I found an article on Index Universe recapping and whether it was there before or not it is there now. There are several other ETFs out from iShares too including Chile.
BKF
http://www.marketwire.com/mw/release.do?id=793917
Roger,
I'm a faithful reader, and find your blog among the most valuable of the fair number I peruse. A truly "decent" junk bond/"high yield" ETF would be a boon for investors like me. I don't do badly picking stocks, but bonds are outside of my "sphere of compentence", so I've only got 2 bond CEFs in my portfolio, GIM and HTR ( I use CEFs and ETFs to play sectors, where I don't know enough to drill beyond sector allocation).
Keep up the good work.
Jan
Roger,
I am 61 and I have been reading and listing to your blog for quite a while. Thank you for you insights and advice. Could you advise me on any changes I should be making in my portfolio, if I send you the names of the funds and the weight of each in relationship to my portfolio.
Thanks,
BWJR
Bill
the generic things I write about are as far as it goes. From a compliance standpoint doling out advice as you are asking about would be the worst thing i could do.
apologies but this is how it has to be. thank you.
High-yield bonds are dubbed junk for good reason. Corporate mortality tables indicate that defaults of high-yield bonds within five years of issuance occur 28% of the time for those just below investment grade and 47% of the time for those with the lowest ratings. Past instances of high default rates lagged periods of strong junk issuance by 4 to 5 years, coinciding with recessionary periods in the economy.[ix]
[ix] Presentation by Dr. Edward I. Altman, "Current Conditions in Global Credit Markets," October 2007.
Above was from:
http://www.investorsinsight.com/otb_va_print.aspx?EditionID=619
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