Can You Trust 'Junk'-Bond ETFs?

By Matthew Hougan

Murray Coleman's recent article paints an ugly picture of how fixed-income ETFs are functioning right now.

Murray focuses on premiums and discounts in the fixed-income space, which is a huge story: Fixed-income ETFs are trading at wild variance with their underlying indexes.

There are a variety of reasons why. The fixed-income market is so frozen right now that some bond price indexes are carrying stale data. At the same time, some ETFs are using "fair value" pricing to value their illiquid holdings, which introduces a layer of discretion into how each fund's assets are priced.

To be honest, it's hard to know exactly where these things should be trading. And that, to me, is a big problem.  

The whole idea of investing in ETFs is that they give you clean access to various asset classes. You set your asset allocation—X% in stocks, Y% in bonds, Z% in commodities—and ETFs give you fair exposure to those markets.

Right now, they are not doing that.

Consider the three junk bond ETFs: the iShares iBoxx $ High Yield Corporate Bond (AMEX: HYG), SPDR Lehman High Yield Bond ETF (AMEX: JNK) and PowerShares High Yield Corporate Bond Portfolio (AMEX: PHB).  All three funds track high-yield corporate bonds, holding portfolios of 50, 112 and 52 high-yield bonds, respectively. You'd think their returns would be similar.

But let's say you bought shares in each fund at the close of trading on October 3. Since then, through 3:30 p.m. ET on October 13, HYG is down about 8.5%, while PHB was down 15% and JNK was down 17%. That's an 8.5% swing in 10 days from top to bottom.

It's worse if you look intraday. At one point last Friday, HYG was down about 15%, JNK was down about 20% and PHB was down nearly 30%. 

A 15% difference? Intraday? Are you serious?

Of the three funds, HYG appears to be trading the best. On an intraday basis it has been trading fairly smoothly, while the other two ETFs have vacillated wildly.

But with HYG trading at a massive discount to net asset value, who's to say.

Buyer beware.

Comments

[CloroxCowboy:]

This article takes a dangerously narrow view and ignores the possibilities that exist with the current yields. Being a young investor, I'm buying these steadily on the way down, reaping increasingly more pleasing payments along the way. I also have the luxury of a long horizon to let prices bottom out whenever they choose and sell at a profit later. I realize that not everyone has time on their side, but those people shouldn't be involved in junk funds for that very reason.

2008 Nov 14 09:14 AM