2012 should be a good year for investors in high-yield bonds, particularly if domestic stock and bond markets suffer a pronounced correction and/or the economy descends into recession. The key to success for investors in high yields will be effective risk management and disciplined trading, according to Stephen Blumenthal, CEO of Capital Management Group.

Fixed Income ETFs: High-yield bonds to shine in 2012 and beyond.

“The yield on high-yield bonds remains attractive, at approximately 8.00%,” Blumenthal noted (Source: Barclays Capital). “More attractive is the spread between these and safer alternatives, like US Treasuries. The spread is now 6.15% over the roughly 1.85% yield on 10-year Treasury bonds, far exceeding the 4.25% average yield spread that has prevailed since 1987.

“The size of this spread over the historical average provides a degree of cushion against sudden negative consequences should our market outlook prove correct. If the economy avoids recession and has a good year, the return for high-yield bond funds should also be attractive given their current high yield.

“To be sure, investing in high yields is not a safe bet, but with the comparatively anaemic yields available from safer Treasury bonds, it’s an alternative for investors who are willing to assume the additional risk in return for greater yield.”

Blumenthal cautioned that he does not advocate that individual’s buy high-yield bonds unless they are fully aware of the risks and are able to trade into and out of these bonds as conditions warrant. For example, his firm runs a risk-sensitive high-yield strategy that calls for tracking high-yield prices on a daily basis, exiting the market when he feels a top has been achieved, switching to safer and liquid money market funds while high-yield bond prices decline, then re-entering the high-yield market when prices are lower and yields are higher.

“I have been trading the high-yield bond market for nearly 20 years. When yields are high and spreads are high, as they are now, the reward potential is greater. We trade with very tight stop/loss parameters and we have learned that high-yields tend to trend in a predictable way. When one starts at a high current yield level, this increases the potential for favourable forward returns regardless of which directions the markets take. Of course, past performance of any investment strategy including our high-yield trading strategy cannot predict or guarantee future returns.

“At this point, with the US awash in unfunded liabilities and the European Union facing unprecedented challenges to its future solvency, I believe that a global recession is the immediate risk. If I am correct in my view, we will see a major market correction later this year and a likely recession. This will result in an attractive decline in high-yield bond prices and an accompanying increase in yields, as bond prices and accompanying yields move inversely to one another.

“Our aim, one we have realised in roughly similar market environments, is to exit near the top of intermediate-term high-yield bond market prices and re-enter this market at what we perceive to be intermediate price trend lows. If conditions are favourable, which I believe they will be, I foresee 12% yields on the horizon, up from 8% currently. If I am incorrect, then we will continue to ride the price trend higher and capture a historically attractive high current yield.”

Slow growth periods pressure less credit worthy companies in search of capital, Blumenthal continued, forcing them to offer bonds at higher yields than are available to more credit worthy borrowers. “This is simply because they represent a higher default risk and have to pay what is often a substantial premium to attract investors,” he noted. “I believe high-yield strategies are well positioned to maximise returns over the years ahead, as borrowers – both corporate and government – respond to increasing competition for capital by offering investors higher risk-adjusted returns.

“In terms of more immediate timing, my firm is currently invested in high-yield bond funds in anticipation of outsized returns that tend to surface during the historically favourable December – April period. However, investment risk remains quite high, so, as always, we trade with a strict stop-loss risk management discipline designed to mitigate potential losses and achieve above par returns.”

For investors looking to gain exposure to high-yield bonds, there is a growing list of tracker, active and leveraged ETFs to choose from:

iShares Markit iBoxx $ High Yield Capped Bond ETF (LON: SHYU)
The Markit iBoxx USD Liquid High Yield Capped Index consists of the most liquid US dollar-denominated corporate bonds with a sub-investment grade rating, while maintaining a focus on UCITs eligibility. The maximum original time to maturity is 15 years and the minimum time to maturity is three and a half years for new bonds to be included and three years for bonds that already exist in the index. For diversification purposes the weight of each issuer in the index is capped at 3%. The fund has an expense ratio of 0.50%.

Lyxor iBoxx EUR Liquid High Yield 30 ETF (LON: YIEL)
The Markit iBoxx EUR Liquid High Yield 30 Total Return index includes 30 of the most liquid bonds making up the Markit iBoxx EUR High Yield Core Cum Crossover index, representing the scope of high-yield, Euro-denominated non-government bonds. The fund’s total expense ratio is 0.45%.

iShares Markit iBoxx Euro High Yield Bond ETF (LON: IHYG)
The Markit iBoxx Euro Liquid High Yield Index offers exposure to the largest and most liquid euro-denominated corporate bonds with sub-investment grade rating. Only bonds with a minimum amount outstanding of €250 million are included in the index. The maximum original time to maturity is 10.5 years and the minimum time to maturity is 2 years for new bonds to be included (no minimum restriction for bonds already in the index). For diversification purposes the weight of each issuer in the index is capped at 5%. The fund has an expense ratio of 0.50%.

SPDR Barclays Capital Euro High Yield Bond ETF (LON: SYBJ)
The Barclays Capital Liquidity Screened Euro High Yield Bond Index includes fixed-rate bullet, puttable, and callable senior debt publicly issued in the Eurobond and index-member domestic markets. The maturity must be between one and up to (but not including) 15 years, and fixed-to-floating rate securities will not be included. The principal and coupons must be denominated in EUR and have a minimum par amount outstanding of €250 million. The fund’s total expense ratio is 0.45%

EasyETF iTraxx Crossover ETF (Xetra: EICEUR)
The objective of this ETF is to offer investors easy access to the European high-yield credit market. It is managed through “synthetic replication”. The recommended investment horizon for this ETF is 3 years.  iTraxx indices are synthetic and mimic Credit Default Swaps (CDS) with reference to the quality of the selected companies, according to Markit criteria. The iTraxx Crossover on-the-run series offers an immediate exposure to credit derivatives on 50 European names in the high-yield universe, issuers with a rating below BBB- (Standard & Poor’s) or Baa3 (Moody’s), whose premiums are higher than those of the investment grade universe. The fund has a management fee of 0.25%.

Guggenheim Bulletshares 2012 High Yield Corporate Bond ETF (NYSE: BSJC)
Guggenheim Bulletshares 2013 High Yield Corporate Bond ETF (NYSE: BSJD)
Guggenheim Bulletshares 2014 High Yield Corporate Bond ETF (NYSE: BSJE)
Guggenheim Bulletshares 2015 High Yield Corporate Bond ETF (NYSE: BSJF)
The above Guggenheim funds are designed to represent the performance of a held-to-maturity portfolio of US dollar-denominated high-yield corporate bonds with effective maturity at year end in their respective year. They each have an expense ratio of 0.42%.

AdvisorShares Peritus High Yield ETF (NYSE: HYLD)
Actively managed, the investment objective of the Peritus High Yield ETF is to generate a high current income with a secondary goal of capital appreciation. HYLD is sub-advised by Peritus I Asset Management. Peritus seeks to achieve the fund’s objective by selecting a focused portfolio of high-yield debt securities that, via their coupons, generate a high current income stream. Peritus takes a value-based, active credit approach to the markets, largely foregoing new issue participation, favouring instead the secondary market where Peritus believes there is less competition and more opportunities for capital gains. Peritus de-emphasises relative value in favour of long-term, absolute returns. The fund’s net expense ratio is 1.36%

Pimco 0-5 Year High Yield Corporate Bond Index ETF (NYSE: HYS)
The Pimco 0-5 Year High Yield Corporate Bond Index Fund is designed to capture, before fees and expenses, continuous exposure to the short maturity segment of the high-yield corporate bond sector. The fund tracks the BofA Merrill Lynch 0-5 Year US High Yield Constrained Index and aims to achieve the yield, volatility level, and low or negative correlations with other asset classes inherent in short maturity high-yield. The fund’s total expense ratio is 0.55%

SPDR Barclays Capital High Yield Bond ETF (NYSE: JNK)
The SPDR Barclays Capital High Yield Bond ETF seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the Barclays Capital High Yield Very Liquid Index . This index measures the performance of publicly issued US dollar-denominated high-yield corporate bonds with above-average liquidity. The fund has a gross expense ratio is 0.40%

PowerShares Fundamental High Yield Corporate Bond ETF (NYSE: PHB)
The PowerShares Fundamental High Yield Corporate Bond Portfolio (ETF) is based on the RAFI High Yield Bond Index. This index is comprised of US dollar-denominated bonds registered for sale in the United States whose issuers are public companies listed on major US stock exchanges. The RAFI methodology for fixed income selects and weights securities using fundamental measures (such as cash flow, sales, book value of assets and dividends) of issuer size rather than market value of debt outstanding. The fund’s total expense ratio is 0.50%.

ProShares Ultra High Yield Bond ETF (NYSE: UJB)
ProShares Ultra High Yield Bond ETF seeks daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of the Markit iBoxx $ Liquid High Yield Index. This index consists of the most liquid US dollar-denominated corporate bonds with a sub-investment grade rating. The fund has an expense ratio of 0.95%.