The world’s largest high-yield bond ETF has come in for some criticism from a bond mutual fund manager at London and Edinburgh-based investment manager Kames Capital.

Stephen Baines, Investment Manager, Kames Capital.

Stephen Baines, co-manager of the Kames Short Dated High Yield Global Bond Fund, says the performance of the iShares iBoxx $ High Yield Corporate Bond ETF (NYSE Arca: HYG), which has returned 70.8%, or 5.5% per annum, over in the ten years since its launch, “looks somewhat disappointing” when compared to the broad high-yield market.

Baines notes that while the performance appears reasonable at first glance, the ETF has fallen short of the broad US high-yield market as measured by the Bloomberg Barclays US High Yield Index, which returned 105%, or 7.4% pa, over the same time frame.

But, as most seasoned ETF investors will tell you, this appears to be comparing Granny Smiths with Braeburns!

HYG tracks the Markit iBoxx USD Liquid High Yield Index, a different index to the Bloomberg Barclays US High Yield Index. Indeed, if you wanted exposure to the Bloomberg Barclays index, you’d buy an ETF linked it, such as the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) which tracks a liquid version of it.

Responding to Baines’s concerns, SSGA‘s Antoine Lesne, head of SPDR ETF strategy, EMEA, and Stephen Yeats, the firm’s head of fixed income beta solutions APAC & EMEA, told ETF Strategy that the fundamental objective of an ETF is to tightly track a specific index and thereby deliver a defined exposure.

They argue that the plethora of bond ETFs available today, tracking a wide variety of indices from broad aggregate to more targeted exposures, has helped to expand the choices available to investors. However, understanding the index underlying the fund, and how it fits in with an investor’s intended exposure, is key.

The pair note that one of the key benefits of passive funds compared to active management is the transparency of the investment process which allows an investor to delve into the strategy and scope of the underlying index to find out the exact risk factors involved.

“When you invest in an ETF, you know it will do what it says on the tin,” says Lesne. “ETFs provide greater information and more choice to investors.”

Kames’s Baines identified what he believes are three potential causes for the underperformance of HYG.

“Firstly, unlike most equity ETFs which are available for a few basis points, the leading high-yield bond ETFs charge management fees which are comparable to many actively managed funds.

“Secondly, unlike an equity index which is relatively static, the entire high-yield bond market rapidly turns over as bonds are issued and redeemed. There is no way to participate passively in this market, as funds need to be highly active in order to keep up with the ever-changing composition of the universe. The only question is how this is done.

“Thirdly, the high-yield bond market is too big to actively track – there are around 1,900 individual securities in the US market, but the major ETFs only hold around 1,000. This means these ‘trackers’ have taken an active decision to ignore hundreds of securities, leaving behind plenty of opportunities for active managers.”

On fees, BlackRock, the fund manager behind HYG, says that while ongoing management costs are important, they are just one criteria that investors take into consideration when they choose what to invest in. According to a spokesperson for the firm, “choice, ease and cost of access are also crucial factors”, with many investors choosing an ETF because the variety available allows them to more accurately match their intended exposure.

SSGA’s Lesne and Yeats say a major benefit of ETFs is the enhanced transparency in the fees charged to investors. They assert that while many active funds clearly state an investment management fee, there may often be several hidden costs involved too. UCITS ETFs, on the other hand, present the total charge for investors within a single total expense ratio.

On the issues of bond index turnover and tracking, BlackRock points out that the number of bonds held by an ETF reflects the underlying index. A different index may warrant more or fewer bonds, but the ETFs are in line with the index and the transparency of the product means that this is visible to investors at all times. “The fundamental objective of our ETFs is to track a chosen benchmark and we develop ETFs based on feedback from clients about what indices they need within a target universe.”

Yeats notes that SSGA harnesses over 30 years’ worth of extensive research into market structure when choosing an index to underlie an ETF and implementing the replication of that index, and that a well-managed sampled approach to replication can effectively track the fundamental risk characteristics of the index, deliver enhanced diversification, and keep costs to a minimum.

In doing so, the smaller, illiquid issues are typically passed over as these bonds are often the most expensive to trade but represent a much less significant part of the index’s exposure. Additionally, while a corporate will typically issue one class of equity security, the same firm may issue upwards of 200 different types of bond securities with various maturities or coupons, for example. Many of these bonds have essentially identical risk characteristics, however, leading to a much smaller pool of bonds required to replicate the issuer’s exposure.

But whatever one thinks of bond ETFs, it is clear the market is voting with its feet. Year to date, fixed income ETFs have gathered more than $100 billion globally, with total fixed income ETF assets now over the $700 billion mark. Within the high-yield segment, ETFs have pulled in $4 billion year to date.

And what about HYG – the ETF in question? It has added about $1.5 billion in net new assets over the past year.