This High-Yield Bond ETF Leaves Room for Improvement

Key Morningstar Metrics for IShares iBoxx $ High Yield Corporate Bond ETF

• Morningstar Medalist Rating: Neutral
• Process Pillar: Below Average
• People Pillar: Above Average
• Parent Pillar: Above Average

IShares iBoxx $ High Yield Corporate Bond ETF HYG provides broad exposure to US high-yield corporate bonds. But difficulties trading these bonds limit its breadth and hamper the advantages of its market-value-weighted portfolio.

The fund tracks the Markit iBoxx USD Liquid High Yield Index, which holds the most-liquid portion of the US high-yield corporate-bond market. Eligible bonds must have at least $400 million in outstanding face value and 1.5 years remaining until maturity. There’s also an issuer-level minimum outstanding face value threshold. The index excludes certain types of bonds, including those with equity and convertible features, floating-rate notes, and bonds from emerging-market issuers. It weights bonds by their market value, subject to a 3% cap on issuers’ weighting in the index.

The resulting portfolio holds a broad and diversified slice of the US high-yield bond market. However, a broad indexing approach leaves much to be desired. The wide return dispersion among the lowest-rated bonds puts it at a disadvantage relative to its Morningstar Category peers. Active managers with more flexibility and sound credit research can use more discretion with riskier bonds to better exploit those that are mispriced. Some managers may take on a small stake in bonds rated BBB to cushion the portfolio during credit shocks.

The index has some shortcomings. It leaves out the less-liquid portion of the market to alleviate transaction costs, but this limits its opportunity set. And market-value weighting tilts the fund toward the most indebted issuers.

Recent fee cuts from other passive high-yield bond funds make the fund’s 0.49% annual fee less attractive, though it still lands in the cheapest quintile of its category. Despite being cheaper than average, it has struggled to consistently outperform the category average.

IShares iBoxx $ High Yield Corporate Bond ETF: Performance Highlights

The fund has a middling track record with fleeting bursts of outperformance, despite its fee advantage. It outpaced the category average by only 8 basis points annualized from its 2007 inception through March 2024. The fund invests across the credit rating spectrum in the high-yield market, and its broad scope allows it to capture credit rallies well. It outperformed the category average by 1.80 percentage points as the market recovered from the coronavirus-driven drawdown between late March and December 2020 when credit spreads rapidly compressed.

However, the wider return distribution among the lowest-rated bonds can dent its performance more than its actively managed category peers with more flexibility. It lagged the category average by 1.57 percentage points at the trough of the pandemic shock in early 2020 and 1.01 percentage points during the 2022 market meltdown.

Difficulties continued in 2023. The fund trailed its average peer by 49 basis points between September and October 2023, when credit spreads rapidly widened as sticky inflation data pushed back expectations for rate cuts. It recouped this loss in the last two months of 2023 as the market bounced back and credit spreads tightened.

This episode demonstrates the fund’s volatility. Its standard deviation of returns clocked in at 9.86% from its 2007 inception through March 2024, versus the category average of 8.78%. The fund’s risk-adjusted return (as measured by Sharpe ratio) was slightly lower than the category average over this period.