SJNK: Looking At The Risk-Reward

Summary

• We reviewed a high yield bond ETF late last year.
• Today, we bring to you another and provide a comparison.
• We may be at a historic inflection point in the credit cycle. What does it mean for the investors of these two ETFs? We will talk about that.
• I do much more than just articles at Conservative Income Portfolio: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

Back in December, we wrote on iShares 0-5 Year High Yield Corporate Bond ETF (SHYG). It yielded investors a healthy 4% real yield, but that came with a generous amount of default risk for this high yield or junk bond ETF. While it definitely did not meet the criteria of being a vehicle to park cash, we did suggest that investors with a higher appetite for risk take a nibble on this rather than some of their investment grade counterparts, to earn something resembling an actual yield.

Today we review another high yield bond fund, the SPDR Barclays Capital Short Term High Yield Bond ETF (NYSEARCA:SJNK) and offer our take. We will also offer comparisons with SHYG, at times using the most current numbers from that ETF's website, as a few have changed since our December piece.

Holdings

Both SJNK and SHYG have around the same number of securities, with SJNK holding 748 and SHYG holding 735, at last count.

Their sector allocations also show striking similarities because they are basically benchmarking to the index.

Source: Compiled from SJNK and SHYG websites

Default Risk

SJNK, as its name suggests has almost all of its holdings in below investment grade investments.

Source: SJNK

Its weightage is similar to SHYG, both holding about 50% of investments rated BB, just a rung below investment grade.

Source: SHYG

High yield bonds by definition are speculative and risky. There is a reason the investors are rewarded with an actual yield rather than smokes and mirrors. The underlying issuers are paying a higher yield as their current business metrics are not strong enough to guarantee honoring of the bond commitments, whether interest or principal at maturity. That is what is broadly called the default risk.

The silver lining for the two ETFs in question, is that majority of their holdings are just a rung below investment grade and not in the deeper recesses of the credit rating world.

Average Bond Maturity

SJNK has almost all of its holdings maturing within 5 years, with a majority at the 3-5 year level. Unsurprisingly, the average maturity for the portfolio comes to 3.38 years.

Source: SJNK

This is higher than SHYG, that has its portfolio more evenly distributed between the various tranches of 1-5 years with a weighted average maturity of 2.04 years.

Source: SHYG

While both SHYG and SJNK portfolios are weighted similarly amongst junk bonds of varied ratings, the lower average maturity for SHYG shields it better against the higher default risk pertaining to their holdings.

Interest Rate Risk

While there is a noticeable disparity between the average maturity in years between the portfolios of the two ETFs, their effective durations are closer to each other. SJNK actually comes in slightly lower at 1.84 years.

Source: SJNK

Compared to SHYG's 1.98 years.

Source: SHYG

It is interesting that the two funds have a very similar effective duration even though their weighted maturities are different. From the investors standpoint, this speaks to the potential rise and fall in the respective portfolio values in the event of a sudden 1% change in interest rates. Thanks to very low durations, both the ETFs are more or less insulated to the same degree in case of interest rates rising from their currently abysmal levels.

Yield

SJNK currently offers 3.50% in real yield to its investors, almost exactly the same as SHYG at 3.49% (noted in the "Portfolio Characteristics" snapshot above).

Source: SNJK

The 30 Day Sec Yield is calculated by annualizing the investment income earned by the fund in the most recent 30 day period. This is unlike the 5.19% in dividend yield which considers the dividends paid out by the ETF in the last 12 month period. The latter does not take into account cumulative impact of the drop in rates over the last 12 months and offers a rosier picture than is.

Currently, SJNK pays its investors $0.1056 in monthly distributions. With the current price of $27.18, the annual yield comes to around 4.66%. In the previous paragraph, we saw that the SJNK notes its 30 Day Sec Yield as 3.50%, but is paying out what amounts to 4.66% based on its last announced monthly distribution. This does happen, as the fund passes through previously realized gains. It does not persist over the long term and reverts closer to what the fund brings in the form of earnings. In the event that it does not happen, it results in NAV depletion for the unitholders as the fund outflows are greater than the underlying interest payment inflows.

In comparison, SHYG pays $0.1966 in monthly distributions, taking it to around 5.17% in annualized yield (current price $45.48). We expect these to revert closer to its real yield of 3.49% in the coming months.

Performance

The ETF website states its mission as seeking to "provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the Bloomberg Barclays US High Yield 350mn Cash Pay 0-5 Yr 2% Capped Index".

Source: SJNK

Except for the current year to date numbers, it has done just that. In 2020, actually beating the index by a modest margin. This is impressive considering the ETF's performance is reflected net of 0.40% annualized expenses, which are absent in the case of the benchmark index.

SHYG too has kept up with the benchmark with its expenses coming in at 0.30%.

Source: SHYG

Conclusion

The two funds offer similar risks and rewards to their investors. Both have almost the same real yield at the moment, however, the lower average maturity for SHYG may allow it to navigate this environment a tad better than SJNK.

Both are trading are the same distance from their NAV at present as well.

Data by YCharts

The biggest risk for these funds might be if we are at a historic inflection point in the credit cycle. As shown below, currently the difference between B rated and CCC rated bonds is one of the lowest on record.

A turn from these levels will likely be unpleasant for high yield bonds in general. For example, in the cycle from June 2014 till February 2016, both provided negative total returns.

Data by YCharts

A similar turn here is probable at some point and will likely wipe out about 2 years of interest payments. Buyers should be aware of the risks here when the credit cycle finally turns.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.