HYG: Largest High-Yield Corporate Bond ETF, But Not A Buy

Summary

  • High-yield corporate bonds offer investors strong yields.
  • HYG is the largest, most popular high-yield corporate bond ETF in the market, but not a buy.
  • An explanation as to why follows.
  • This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »

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Author's note: This article was released to CEF/ETF Income Laboratory members on November 5th, 2021.

The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG) is the largest, most popular high-yield corporate bond ETF. Although HYG has its merits, it is more expensive, lower-yielding, and underperforming relative to most of its peers. Lots of negatives, almost no positives. There are simply much better high-yield corporate bond ETFs out there, so I would not be investing in HYG at

The iShares Broad USD High Yield Corporate Bond ETF (USHY) is most similar to HYG, but with a lower 0.15% expense ratio, and higher 5.1% yield. USHY seems like a strictly superior choice to HYG.

The VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL) and the iShares Fallen Angels USD Bond ETF (FALN) both focus on Fallen Angels, recently downgraded high-yield corporate bonds. These securities tend to outperform due to regulatory issues: recently downgraded bonds see a lot of forced selling from passive institutional investors, and so have abnormally high yields and prices. In my opinion, ANGL and FALN are also stronger high-yield corporate bond funds than HYG, and my top two choices in the space.

HYG Basics

  • Sponsor: BlackRock
  • Underlying Index: Markit iBoxx USD Liquid High Yield Index
  • Expense Ratio: 0.48%
  • Dividend Yield: 4.17%
  • Total Returns 10Y: 6.21%

HYG Overview

HYG is the largest high-yield corporate bond fund in the market. It is administered by BlackRock, the largest investment management firm in the world.

HYG tracks the Markit iBoxx USD Liquid High Yield Index, a high-yield corporate bond index. It is a relatively simple index, including all dollar-denominated corporate bonds from developed-country issuers with non-investment grade credit ratings (BB or less, but mostly BB). Applicable securities must also meet a basic set of liquidity, size, and trading criteria. It is a market-cap weighted index, with a 3% issuer cap. Credit ratings are as follows:

(Source: HYG Corporate Website)

As can be seen above, HYG focuses on holdings with low credit ratings. These securities are issued by companies with relatively weak financials and balance sheets, and are generally quite risky. Expect moderate losses during downturns and recessions: higher than for most bonds, but lower than for equities. This was the case during 1Q 2020, the onset of the coronavirus pandemic.

Chart
Data by YCharts

On other hand, risky, volatile fixed-income securities and funds tend to have comparatively strong yields, and HYG is no exception. The fund yields 4.2%, quite a bit higher than average for bonds in general, all bond sub-classifications, and equities.

Chart
Data by YCharts

HYG's index is relatively broad, investing in the vast majority of relevant high-yield corporate bonds, with few inclusion or exclusion criteria. This makes for a relatively diversified fund, with exposure to most relevant industry segments and maturity dates.

(Source: HYG Corporate Website)

HYG invests in 1,343 different securities. Concentration is quite low, with the top ten of these accounting for just 3.1% of the value of the fund. HYG's diversification is such that the fund is not exposed to significant losses or underperformance in the event of an individual corporate default.

Besides the above, nothing really stands out about HYG or its underlying index. It is a broad high-yield corporate bond index ETF, with a reasonable index, and with holdings reflective of the same.

HYG Negatives

In general terms, HYG is a perfectly adequate high-yield corporate bond index ETF, with a reasonably good yield. Adequate does not mean good, as the fund compares unfavorably to most of its peers in three key metrics: expense ratio, dividend yield, and total shareholder returns. Investing in an expensive, low-yielding, underperforming fund is rarely a good idea, and HYG is no exception. Let's have a quick look at each of these three metrics.

Expense Ratio

Index funds almost always have relatively low expenses, as these are passive investment vehicles with little in operational, trading, and labor costs. Low expenses directly increase, or reduce by less, returns, and are a significant benefit for a fund or its shareholders.

HYG is one of the few expensive index funds out there, with a 0.48% expense ratio. The fund's expense ratio is much higher than that of other broad asset class index ETFs, as well as that of more niche bond sub-asset class funds. Diversified index funds are rarely as expensive as HYG.

(Source: HYG Corporate Website)

HYG's expense ratio is also higher than that of most of its peers, and that of three of my top high-yield corporate bond ETFs: USHY, ANGL, and FALN.

(Source: HYG Corporate Website)

HYG's high expense ratio directly reduces the fund's returns, and is a significant negative for the fund and its shareholders. A good actively-managed fund could plausibly generate sufficient alpha to more than cover its expenses, but that is not really the case for a passive index fund, which simply tracks its index. I see no reason to overpay for a simple index fund, including HYG.

Dividend Yields

The vast majority of ETFs, including HYG, distribute their net investment income, basically dividends and interest payments minus expenses, to shareholders. As such, expensive funds tend to have comparatively low dividend yields, as is the case for HYG. The fund is one of the lowest-yielding high-yield corporate bond ETFs in the market, although FALN, ANGL, and HYS yield a bit less. Still, HYG's yield is quite low, which is a negative for the fund and its shareholders.

(Source: ETF.com)

Total Shareholder Returns

High-yield corporate bonds are income vehicles, with low expected capital gains under most conditions. As such, it stands to reason that an expensive, low-yielding like HYG would underperform relative to its peers, which is indeed the case. HYG has significantly underperformed relative to ANGL and FALN, my top two high-yield corporate bond ETFs, since inception, and for most relevant time periods.

Chart
Data by YCharts

HYG has also underperformed relative to most of its larger peers, with the exception of two short-term high-yield corporate bond ETFs. HYG benefited from lower interest rates / credit spreads in the past, hence the (slight) outperformance.

Chart
Data by YCharts

HYS's lackluster total shareholder returns are a negative for the fund and its shareholders, and mean that the fund lacks a reasonable investment thesis. I would be willing to invest in a fund with lackluster returns if it had other benefits, say comparatively safe holdings, a stronger yield, or a good strategy, but HYG lacks these. It is simply a fund with few positives relative to its peers, but lots of negatives.

Conclusion - Better Choices Out There

HYG is a comparatively expensive, low-yielding, underperforming high-yield corporate bond index ETF. As there are better high-yield bond ETFs out there, I would not be investing in HYG at the present time.

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This article was written by

Juan de la Hoz profile picture
7.7K Followers
CEF/ETF income and arbitrage strategies, 8%+ portfolio yields

Juan has previously worked as a fixed income trader, financial analyst, operations analyst, and economics professor in Canada and Colombia. He has hands-on experience analyzing, trading, and negotiating fixed-income securities, including bonds, money markets, and interbank trade financing, across markets and currencies. He focuses on dividend, bond, and income funds, with a strong focus on ETFs, and enjoys researching strategies for income investors to increase their returns while lowering risk.

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I provide my work regularly to CEF/ETF Income Laboratory with articles that have an exclusivity period, this is noted in such articles. CEF/ETF Income Laboratory is a Marketplace Service provided by Stanford Chemist, right here on Seeking Alpha.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

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