Article #3: The case for high yield bond ETFs - Why I love SPHY.
A passive (“lazy”) investment portfolio based on low cost ETFs is a great way to accmulate wealth over the long term. In the article investing for dual US-Israeli Citizens I showed that two ETFs (Vanguard VT and BSV) are sufficient for constructing an efficient, low cost investment portfolio.
In the article choosing bond ETFs for your lazy portfolio I presented a few options for the bond side of the portfolio.
Now, I'll cover the advantages of allocating a part of the bond holdings to high yield bonds.
This is especially useful for investors who are nearing retirement and thus aim to create a larger income stream from their portfolio.
Needless to say, the percentage of bond holding that should be allocated to high yield bonds in an investment portfolio depends on several factors such as an investor's risk tolerance, investment goals, and market conditions.
High yield bonds, also known as junk bonds, are issued by companies that have lower credit ratings and are considered riskier than investment-grade bonds. As a result, they typically offer higher yields to compensate for the increased risk.
Investors with a higher risk tolerance and a longer investment horizon (and of course those in need of higher income) may consider allocating a higher percentage of their bond portfolio to high yield bonds in the range of 10-20%. However, for investors who prioritize capital preservation and have a lower risk tolerance, a smaller allocation of around 5-10% may be more appropriate.
It's important to note that high yield bonds tend to have a higher correlation to equities and can be more volatile than investment-grade bonds. Therefore, investors should carefully consider their risk tolerance and investment objectives before making any allocation decisions. Additionally, consulting with a financial advisor or investment professional may be beneficial to determine an appropriate allocation based on an individual's specific circumstances.
Here are three examples of quality high yield bond ETFs that can be purchased on the US stock exchange and are especially suitable for US investors or for investors with a dual Israeli-US citizenship:
SPDR’s SPHY tracks the performance of the Bloomberg Barclays High Yield 1-5 Year Bond Index, which includes U.S. dollar-denominated, high yield corporate bonds with maturities between one and five years. The index includes publicly issued USD high yield bonds with a below investment grade rating, at least 18 months to final maturity at the time of issuance, at least one year to maturity, a fixed coupon, and a minimum amount outstanding of $250M. By focusing on shorter-term maturities, SPHY aims to provide investors with a balance of higher yield potential and reduced interest rate risk. As interest rates rise, bond prices tend to fall, and longer-term bonds are generally more sensitive to interest rate changes than shorter-term bonds. Additionally, by investing in high yield bonds, the ETF aims to provide investors with higher yields compared to investment-grade bonds.
iShares iBoxx $ High Yield Corporate Bond ETF (HYG): This ETF seeks to track the investment results of the Markit iBoxx USD Liquid High Yield Index, which includes U.S. dollar-denominated, high yield corporate bonds.
SPDR Bloomberg Barclays High Yield Bond ETF (JNK): This ETF seeks to provide investment results that correspond generally to the price and yield performance of the Bloomberg Barclays High Yield Very Liquid Index.
SPHY is a my personal high yield ETF favorite due to a combination of a very low expense ratio (0.1%), high liquidity, a large number of holdings (1951) and great sector diversification. As of April 2023, SPHY has a dividend yield of 6.67% and has paid $1.52 per share in the past year. Its yield to maturity (the market weighted average rate of return anticipated on the bonds held in a portfolio if they were to be held to their maturity date) is 8.67%.
High-yield bonds may be setting up for historic gains that could potentially surpass US equity returns in the next few years.
If the US Fed reduces interest rates in the next couple of years, the current price of SPHY can be a rather attractive entry point for investors seeking to lock in the current high yield of this ETF.