Rising interest rates have been hard to miss for income investors. 10Y Treasury yields have almost doubled since the start of the year and risen above 3% – a development that has also hammered many income assets.
Historically, fixed-income investors have had to make a choice – move out the yield curve to increase duration exposure and earn a higher yield or decrease duration exposure by moving down the yield curve but earn a lower yield. This trade-off in duration exposure vs yield is a direct result of the fact that the yield curve is generally upward sloping so that longer-term bonds carry a higher yield than shorter-term bonds. Typically, investors who want to generate a higher yield without taking on more credit risk need to take more duration risk.
This relationship has recently broken down. Investors can now generate the same or higher yield by taking less duration exposure.
Let’s take a look at two screenshots below. This one shows the yield profile of SJNK – a high-yield corporate bond ETF with a duration profile of 2.44.
And this screenshot show the yield profile of the benchmark SPDR Bloomberg High Yield Bond ETF (JNK) with a duration of 4.27.
The yields highlighted in both screenshots are the yields that matter to investors. These are the yields that investor capital actually accrues in these funds. We can see that SJNK has a 0.09% higher weighted-average yield-to-worst than JNK. The credit rating profiles of the two funds are similar.
The key takeaway here is that SJNK offers a higher yield than the “typical” high-yield corporate bond fund while requiring investors to take almost half as much interest rate risk. That sounds pretty good!
Now what is this about a 7.71% yield when SJNK has a 5.09% distribution rate? The key point here is that while SJNK distributes a yield of 5.09% its underlying bond portfolio accrues yield at a 7.71% level. It’s not clear why SJNK is so miserly with its distribution but it likely has to do with the fact that the fund’s yield-to-worst is more volatile than its current yield and it’s the current yield that tends to drive the distribution rate. The yield-to-worst has spiked up recently more than the current yield because it takes into account the portfolio pull-to-par which is the additional tailwind investors get when the weighted-average price is below par as it is now at $95.80.
Thanks for reading.
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