Exchange-traded funds (or ETFs), as the name suggests, are funds that trade like a stock on the stock exchange. Much like mutual funds, they also track an index, commodity, or a basket of assets, to provide derived returns to its investors. Investing in an ETF gives you the advantage of diversification along with the ability to trade on a stock exchange. Given the popularity of ETFs, there are numerous kinds available for trading in the market like the U.S. market index ETFs, foreign market index ETFs, sector and industry ETFs, bond ETFs, inverse ETFs, and leveraged ETFs, to mention a few.
High yield bond ETFs, like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Barclays Capital High Yield Bond ETF (JNK), essentially track a high-yield bond index (which is the MarkitiBoxxA USD Liquid High Yield Index in case of HYG, and the Barclays Capital High Yield Very Liquid Index in case of JNK), in order to replicate the high returns. Given the high yield that it tries to attain, returns from such ETFs are more susceptible to market volatility, such as changes in interest rates caused by inflation or a change in policy.
Similarly, leveraged loan ETFs, like the Pyxis/iBoxx Senior Loan ETF (or SNLN) and the PowerShares Senior Loan Port (BKLN), track the MarkitiBoxx USD Liquid Leveraged Loan Index , and the S&P/LSTA U.S. Leveraged Loan 100 Index, respectively. They do this with a view to attain the market-weighted performance of the largest institutional leveraged loans. Returns from the leveraged loan ETFs are better placed than high yield bond ETFs in terms of volatility, as the underlying loans are usually of a floating-rate nature and are bench marked to the London Interbank Offer Rate (or LIBOR).
The risk-return game
Investors investing in these ETFs can easily be differentiated on the basis of their risk appetite. The high yield bond ETF investors like Sprint Corporation (S) and HCA Holdings, Inc. (HCA) are ready to take on more risk in the quest of higher returns. Leveraged loan ETF investors are less risk savvy and are satisfied with earning just above the benchmark rate.
Read on to see how an investor’s preference for high yield bond ETFs and leveraged loan ETFs changes with the investment climate.