A lot of income investing comes down to maximizing the yields on offer while minimizing the risks investors are required to take to achieve those yields. In this post, we take a quick look at term ETFs across High Yield, Investment Grade and Tax-Exempt sectors and highlight how investors can achieve most of the yield while minimizing their duration exposure.
Term ETFs are funds that hold bonds maturing, roughly speaking, in a given year. The advantage of these products is that investors can tailor the yield of the fund versus its duration and credit risk. This is in contrast to funds that hold securities with a mix of maturities.
We take a look at the following funds:
- Invesco BulletShares ETFs
- BlackRock iBonds ETFs
Both BulletShares and iBonds have Investment Grade Corporate, High-Yield Corporate and Investment-Grade Tax-Exempt Muni funds. The fees are similar – IG funds for both charge 0.10%, Muni funds charge 0.18% and iBond HY funds charge 0.35% while BulletShares charge 0.42%.
All the funds are passive and are periodically rebalanced in line with their indices which are different between the two fund managers, though they very likely have significant overlap.
The chart below plots the funds’ net yields-to-worst (y-axis) versus their term (x-axis). The net yield-to-worst is defined as simply the fund’s portfolio yield-to-worst less the fund’s fee. This number is what the investor will earn on their capital in the fund, before any defaults or portfolio turnover. It’s important to point out that it is not what the fund distributes but it is the cleanest metric of investor “yield”. HY funds for both fund managers are shown in red, IG funds in green and Muni funds in orange.
The chart shows a few interesting things. First is the obvious fact that HY funds (red dots) have higher yields than IG funds (green dots) which have higher yields than Tax-Exempt Funds (orange dots).
Two, the yields are upward-sloping – longer-term funds tend to have higher yields. This makes sense as both the Treasury yield curve and the credit spread curve are upward sloping, at least at the front-end.
Three, HY fund yield curve rises but falls off pretty quickly after about 2025. In our view, this is the most important takeaway from the chart. The key point here is that the sweet spot in HY bonds is between 2024 and 2026. Investors who hold longer-dated bonds are not earning higher yields and just taking on more duration risk.
In our view, the following two funds offer value for investors:
- iShares iBonds 2024 Term High Yield and Income ETF (IBHD) at a 7.03% net yield-to-worst. IBHD has an effective duration of 1.9 and a weighted-average maturity of 2.07 years.
- iShares iBonds 2026 Term High Yield and Income ETF (IBHF) at a 7.42% yield-to-worst. IBHF has an effective duration of 3.2 and a weighted-average maturity of 3.84 years.
Thanks for reading.
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