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A Higher Quality Junk Bond ETF That is Outperforming

With potential credit and rate risks weighing on the fixed-income markets, investors who are looking for higher yields may turn to an actively managed junk bond exchange traded fund that has outperformed more popular investment funds.

The First Trust Tactical High Yield ETF (HYLS) , an actively managed ETF that tracks high-yield debt securities rated below investment grade, has been outpacing its competition, or at least has not performed as poorly as other junk bond ETFs. Year-to-date, HYLS dipped 0.8%, whereas the SPDR Barclays High Yield Bond ETF (JNK) fell 8.2% and iShares iBoxx $ High Yield Corporate Bond ETF (HYG) declined 6.8%. [Is the Selling in Junk Bond ETFs Overdone?]

HYLS’s outperformance may be attributed to the management team’s ability to adapt to shifting market conditions. For example, the ETF has targeted lower maturity debt securities to diminish the negative effects of rising rates and eschewed riskier energy and materials sector debt.

The First Trust Tactical High Yield ETF has a 3.24 year average duration, or the measure of a bond fund’s sensitivity to changes in interest rates – a 1% hike in rates would translate to about a 3.24% decline in the fund’s price. The fund also hedges against rising rates through some bearish or short bets on U.S. Treasuries. Due to the lower duration, HYLS has a slightly lower 6.47% 30-day SEC yield.

The fund’s credit quality break down includes investment-grade BBB 1.4%, along with speculative-grade BB+ 3.6%, BB 6.0%, BB- 14.0%, B+ 18.3%, B 22.0%, B- 15.9%, CCC+ 16.5% and CCC 2.1%. [Don’t Associate Junk Mutual Fund Problems with Bond ETFs]

More importantly, energy and materials are absent from the ETF’s top sector weights. HYLS includes 12.3% health care providers & services, 12.1% media, 9.0% hotels & restaurants, 7.6% food products, 6.0% pharmaceuticals, 5.9% diversified telecom services, 4.2% food & staples retail, 4.0% health care equipment & supplies, 3.5% specialty retail and 3.4% life sciences tools & services.

Fixed-income observers have grown increasingly wary of energy and materials sector debt as the commodities market plunged over the past year. Many are concerned that we will witness greater defaults among energy producers as oil prices remain stubbornly low. Meanwhile, miners are also in a precarious situation after demand for industrial metals, notably from China, declined as the global economy weakened.

In contrast, broad index-based junk bond ETFs include greater weights toward these riskier segments. For instance, HYG holds 10.6% in energy company debt.

However, potential investors should be aware that due to HYLS’s active management and use of short sales, the fund comes with a high 1.29% expense ratio.

For more information on the speculative-grade debt market, visit our junk bonds category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.