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Why Fixed-Income Investors Should Consider an Active High Yield Bond ETF

This article was originally published on ETFTrends.com.

Fixed-income investors should consider the benefits of an actively managed ETF approach to high yield bonds as a way to help enhance their bond portfolios.

On the recent webcast (available On Demand for CE Credit), Everything You Need to Know About High Yield Bonds in Today’s Market, Michael DePalma, CEO and Senior Portfolio Manager at Phase Capital, listed off a number of reasons why fixed-income investors should consider an active high-yield strategy, including high current income, low correlations to other asset classes, attractive risk-return profile, limited sensitivity to interest rates and the potential for added value. Michael Venuto, Chief Investment Officer of Toroso Asset Management, also added that "active allows high yield to be a strategic investment."

Specifically, high-yield bonds, like their names suggest, provide opportunities for enhanced yields. Since 1994, the high yield bond market has exhibited an average spread of 509 basis points above Treasuries.

High-yield bonds may offer diversification benefits as the category has exhibited low correlation to other fixed-income segments and stocks. High-yield bonds showed a 0.58 correlation to large-cap stocks, 0.29 correlation to Aggregate Bonds, 0.34 correlation to municipal bonds, 0.06 correlation to U.S. Treasuries and 0.04 correlation to gold.

In a rising rate environment, with the Federal Reserve eyeing a tighter monetary policy and interest rate normalization, high-yield bonds may outperform. High-yield bonds have historically exhibited a lower sensitivity to interest rate changes. During periods of rising rates, high-yield assets have returned a mean 4.23%, compared to the -1.22% decline in investment-grade debt and -2.46% drawdown for U.S. Treasuries.

Investors may also look to an actively managed strategy as passive strategies have done poorly in less efficient markets, whereas active managers are capable of quickly adapting to sudden market changes, according to DePalma.

Specifically, DePalma pointed to the changing macroeconomic and financial conditions in the market cycle. The economy is past the expansionary period and is in the moderation phase that precedes the contraction phase of the traditional market cycle. During this moderation and contraction period, corporate loans have traditionally outperformed while lower quality speculative-grade debt underperformed, which is a stark contrast to yesteryear during the expansionary and recovery phase of the market cycle.

Looking ahead, DePalma argued that the current market cycle indicator suggest a recession in six to 18 months. Consequently, high-yield investors may reduce portfolio beta, move up in credit quality, move up the capital structure and shorten duration to hedge potential risks down the road.

High-yield bond ETF investors who are interested in a more dynamic investment strategy that can adapt to the changing market conditions could consider an active bond ETF like the High Yield ETF (HYLD) . HYLD seeks high current income with a secondary goal of capital appreciation. The sub-advisor seeks to achieve the fund’s investment objective by selecting a focused portfolio of high-yield debt securities, which include senior and subordinated corporate debt obligations like loans, bonds, debentures, notes and commercial paper.

DePalma explained that HYLD is backed by a team with decades of experience and integrates systematic macro insights, fundamental credit research and proactive risk management to achieve its objectives and seeks to add excess return. The active strategy focuses on USD high-yield bonds and loans. The managers also focus on smaller issuers that are ignored by most, delivering the opportunity for higher yields per unit of risk and better diversification as part of a total portfolio solution.

"We actively managing risk and strive to limit exposure to large losses," DePalma said.

"By dynamically allocating risk based on where we are in the cycle, we expect our strategy to deliver on its objectives in all market environments," he added.

Financial advisors who are interested in learning more about the high-yield market can watch the webcast here on demand.

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