Bond ETF Adds Competitors To Portfolio

An interesting note is that PowerShares High Yield Bond (NYSE: PHB) for a short-time held the SPDR Barclays Capital High Yield Bond (NYSE: JNK) and the iShares iBoxx High Yield Bond Index (NYSE: HYG) as part of its creation unit to better access the index's bonds. 

The two ETFs are no longer part of the underlying holdings but as of the end of 2008, PHB held 5.01% in JNK and 4.77% in HYG, according to Morningstar. 

This shows that ETFs are a tool that they can be utilized by other ETFs to fulfill their index tracking objective -- especially in extreme circumstances. 

Secondly, there was a disturbance in the underlying holdings which lead them to hold the ETFs instead of individual bonds.  The fact that the PowerShares ETF, PHB, had such extreme premiums and discounts on certain trading dates shows problems with the underlying basket of bonds that the other high yielding ETFs did not have. 

That could explain why management needed to add the two competing ETFs to their creation unit.

As the chart below shows, the three high-yield bond ETFs have similar characteristics and quality. All three are considered low quality; intermediate bond funds which track their respective indexes. 

Even though they have many similarities and returned around the same performance during normal conditions, during the credit crisis vast differences in performance was seen.

As we can see below, the differences did not come from average qualities but happened because credit problems were realized in underlying holdings. 

Becoming familiar with how the ETF and its index will perform and function in extreme market conditions is important by studying the premium and discounts the ETF has to NAV and total return over abnormal market conditions.

Last year was a test for bond ETFs and gave a way for investors to look deeper into their functions and better understand the total picture of high-yield bond ETF risks.

Kyle Waller is a research analyst at Wiser Wealth Management in Marietta, Ga. He invites comments and suggestions for future columns at:  This e-mail address is being protected from spambots. You need JavaScript enabled to view it .

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