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By Eric Dutram

Actively managed ETFs have been slow to gain traction so far among most investors for a variety of reasons. Higher than average fees, a boatload of academic evidence suggesting inability of active management to consistently generate alpha, and concerns about disclosure requirements leading to front-running opportunities have all contributed to the relatively slow adoption rate of active equity ETFs. However, while actively-managed ETFs have been slow to catch on in highly liquid and transparent markets – such as large cap U.S. stocks – they have seen a fair amount of interest from investors looking to access asset classes that are generally less efficient. That phenomenon shouldn't be surprising; there is some evidence that active management may be able to add value in harder-to-price sectors, such as smaller emerging equity markets or corners of the fixed income market. One example of a successful active ETF is the WisdomTree Dreyfus Emerging Currency Fund; CEW, which offers exposure to a basket of emerging market currencies, has accumulated more than $500 million in AUM. Another active ETF that is beginning to turn heads among investors is the Peritus High Yield Bond ETF (NYSEARCA:HYLD) from AdvisorShares, which has begun gaining traction thanks to an impressive early performance record.

HYLD is a relatively new fund from AdvisorShares, one of the largest issuers of active ETFs. The fund debuted in December of 2010 as the first actively-managed ETF in the junk bond space, seeking to offer investors a new way to gain exposure to an asset class that has seen a surge in interest as rates have hovered near record lows. In recent years, many analysts have pointed out the potential pitfalls of fixed income indexing, including tendencies of many bond benchmarks to tilt portfolios towards issuers with the largest debt burdens [see Are Bond ETFs Broken?]. The Peritus investment methodology is designed to avoid some of these drawbacks by utilizing a number of novel strategies and methods which look to offer investors a better profile in the space. First, the company looks to avoid many of the highly leveraged buyouts which tend to dominate junk bond indexes but may be impaired over the next few years, especially if interest rates rise or if the economy backslides [Three Country ETFs For A Double Dip].

Additionally, it should be noted that the fund uses a "Hedged HY" strategy, which means that from time to time HYLD may utilize U.S. Treasuries in an effort to hedge against adverse market declines. In other words, when the credit spreads on junk bonds narrow to a certain level, this fund has the flexibility to shift its holdings into low-risk Treasuries that often perform quite well when lower quality debt comes under pressure. The opportunity cost in adding Treasuries to the portfolio (in the form of a lower yield) can be significant, but a well-timed shift can have obvious advantages as well – and the flexibility to implement such a shift is obviously not found in many fixed income ETFs [see more on HYLD's Fact Sheet].

Lastly, the main difference between this fund and some of the more passive products in the space is the fund's lack of focus on credit ratings. Peritus takes the view that either securities will pay out or they won't; there really is no in-between. Furthermore, the fund does not invest in any new issues of bonds preferring to let the market set the price initially and then find mispricings afterwards. This method has two benefits for investors; first, it removes the chance that credit rating agencies have grossly underestimated the appetite for certain bonds and avoids the large flux that can come directly after a bond hits the market. Additionally, a focus on secondary issues allows the fund to have a lower duration than other comparable products.

Junk Bond ETFs Head To Head

Ticker ETF YTD Gain*
HYLD High Yield ETF 6.5%
PHB High Yield Corporate Bond ETF 5.5%
JNK SPDR High Yield Bond ETF 5.3%
HYG High Yield Corporate Bond Fund 4.7%
*As of 5/27/2011

The blend of active management, the exchange-traded structure, and junk bond exposure has so proven to be a successful mix. So far in 2011, HYLD has outperformed all the other products in the High Yield Bond ETFdb Category by a wide margin, more than justifying the higher-than-average fees. In fact, this year HYLD has outperformed other junk bond ETFs by 100 basis points or more, and has returned roughly 1.8% than the most popular fund in the space, the iShares iBoxx $ High Yield Corporate Bond Fund (NYSEARCA:HYG). HYLD also offers a higher yield and a lower duration than comparable products as well, in some cases offering as much as 200 additional basis points on certain yield metrics.

HYLD's stellar start to 2011 certainly isn't proof that active management is staging a comeback, or even that it is a universally superior approach in this corner of the fixed income space. But for investors frustrated with the performance drags created by the methodologies behind many fixed income funds, the idea of turning over management to an experienced team may be appealing – at least in certain asset classes. And the relative performances so far in 2011 are proof that bigger isn't always better; sometimes, it pays to look beyond the most popular options in any one category.

Disclosure: No positions at time of writing.

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Original Article

Source: Junk Bond ETFs: HYLD Leading the Way