Active US High Yield: A new frontier for ETFs
- 31 May 2024 (3 min read)
Traditionally the domain of passive equity investing, today’s ETF market offers far more choice than ever before. Thanks to exciting product innovations in recent years, ETF investors can now enjoy access to many areas of the investment spectrum, while maintaining the potential benefits of an ETF structure. In particular, fixed income ETFs saw record net sales over 2023 of $305.9 bn, while active/semi-active ETFs enjoyed estimated net inflows of $136.2bn over the calendar year.1
In our view, the expansion of the ETF product line into previously untapped areas does not replace more traditional uses of ETFs such as indexed equity, but rather compliments this by offering exposure to a broader opportunity set within a diversified portfolio. For example, high yield (‘HY’) corporate bonds are less well-known than equities in the ETF space. However, they can work just as well for ETF investors as a diversifying tool offering potentially higher income and lower volatility than equities.
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The role of US high yield in portfolios
Fixed income has long provided a crucial role in any balanced portfolio. HY bonds are considered to carry a higher default risk than government or investment grade corporate debt (or credit), but to compensate for this, they offer the potential for higher rates of income.
The HY bond market was born in the US and that remains the largest and most liquid market offering a diverse opportunity set. Importantly, diversification doesn’t just come from issuer sectors and industries, but also from credit rating and maturity, meaning a high yield portfolio has access to multiple levers from which to aim to generate alpha. This is why active management could be worth considering, especially in an environment where the policy, growth and inflation outlook remains so uncertain.
Despite this uncertainty, a healthy US economy is providing a favourable fundamental and technical backdrop for high yield bonds. US corporate credit fundamentals are in fairly good shape, and the high yield default rate is relatively benign. Furthermore, valuations from a yield perspective appear compelling and offer a potential buying opportunity.
Against this backdrop, the US HY market has the potential to deliver an attractive total return over the coming 12 months, driven by coupon income. This could be of considerable interest to ETF investors looking for ideas to deploy the elevated cash levels built up over the past couple of years as we get closer to a potential US rate cut, even if the timeline is difficult to predict.
At a time where ETF investors are increasingly crying out for more innovative options to access the attractive opportunities across the fixed income landscape, active US High Yield ETFs may provide another compelling option in the investor toolkit.
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