In the current environment of ultra-low rates, yield-starved investors continue to search for products with higher levels of income. A number of new products have been launched in the ETF universe in order to cater to such investors, including an actively managed preferred share ETF by First Trust—Preferred Securities & Income (FPE - ETF report), an ETF investing in business development companies—Market Vectors BDC Income ETF (BIZD - ETF report), three MLP ETFs—Global X Junior MLP ETF (MLPJ - ETF report), iPath S&P MLP ETN (IMLP - ETF report) and and Yorkville High Income Infrastructure MLP ETF (YMLI - ETF report), a Put Write ETF—US Equity High Volatility Put Write Index Fund (HVPW - ETF report) and an actively managed global corporate bond ETF by WisdomTree
Many investors have poured a lot of money into high yield bond funds in the last couple of years but since there are concerns that the interest rates may start going up later this year or next year, some of the investors are looking for products that can provide at least hedge against the interest rate risk. (Read: 3 Excellent ETFs for Income Investors)
The new actively managed ETF following long/short strategy from First Trust is another product targeting yield starved investors. The product seeks to provide higher level of income by investing in high yield bonds but at the same time reducing the interest rate risk to some extent.
The First Trust High Yield Long/Short ETF (HYLS - ETF report) was listed on NASDAQ on February 27, 2013.
FPE in Focus
HYLS seeks to provide current income by investing primarily in a diversified portfolio of below-investment-grade or unrated high-yield debt securities, including U.S. and non-U.S. corporate debt obligations, bank loans and convertible bonds. (Read: ALPS Launches New Income ETFs)
According to the filing
, the fund will invest up to 80% of its net assets in junk securities. Further, the fund may invest up to 10% of its net assets in non-U.S. securities denominated in non-US currencies. The fund intends to maintain both long and short positions—long positions in securities that the ETF advisors believe have the potential to outperform the fund’s benchmark Bank of America Merrill Lynch U.S. High Yield Master II Constrained Index and short positions in securities expected to underperform the index.
Further, according to First Trust, since the historical correlation between high-yield securities and traditional fixed-income instruments is low, the addition of high-yield securities to a well-diversified portfolio has the potential to improve returns and reduce overall portfolio volatility due to diversification befits. (Read: Time for Inverse Bond ETFs)
As of the date of writing, the fund held 58 holdings, but with the assets well spread out among the holdings, as the top ten holdings currently account for only about 25% of the total assets. In terms of asset classes—corporate bonds and notes dominated with 86% of the assets, while senior floating-rate loan interest accounted for 12% of the holdings.
Weighted average maturity of the long positions was 6.59 years while the weighted average duration was 3.91 years. Additionally, the fund held short position of 24.63% in the US Treasuries.
Can it succeed?
The strategy looks attractive but it basically bets on the tightening of the spread between the junk bonds and treasuries. There has been a lot of investor interest in junk bonds as the default rate has remained low. According to the prospectus, current high yield spreads are near 517 basis points compared with a historical mean of 591 bps and a median of 536 bps. They expect the spread to tighten since the default rate remains much below the historical average.
Below is a chart showing the historical spread:
Further, the product is a bit expensive with an expense ratio of 1.19% per annum—0.95% in management fees, 0.23% in leverage costs and 0.01% in acquired fund fees and expenses.
Though this is the first product launch, there are some other products in the pipe-line based on similar strategy. Van Eck recently postponed the launch of Market Vectors Treasury hedged high yield bond ETF (THHY).
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