Alliance Bernstein asks: Are ETFs the best vehicle for high yield investors?

Ashish Shah, head of Global Credit and Gershon Distenfeld, director of High Yield at Alliance Bernstein say investors in this sector should stick to bonds not ETFs.

High-yield exchange-traded funds (ETFs) have been growing like gangbusters in recent months, despite continued weak performance relative to the indices that they track. While these instruments make sense for investors who make rapid, tactical trades into and out of the asset class, we think they’re a poor choice for those seeking to gain long-term exposure to high-yield bonds.

Torrential flows

Early in 2012, the steady flow of funds into the high-yield ETF market became a torrent. Although ETFs still represent just 2% of the high-yield market, about one-third of the flows into the high-yield bond market this year have gone into ETFs. What’s the appeal?

First of all, high-yield bonds themselves are attractive. With interest rates at historic lows around the developed world, there are few remaining bond sectors that still offer attractive yields. And as we’ve written before, high-yield bonds have historically offered comparable returns to equities, with about half the volatility. That’s an attractive proposition for investors looking to reduce their portfolio risk.

Second, high-yield ETFs appear to offer a convenient vehicle for exploiting this opportunity. ETFs in and of themselves are relatively liquid. Unlike mutual funds, which are priced just once a day, ETFs are traded on exchanges and thus can be bought or sold at any time, just like stocks. Also, management fees for ETFs are lower than for actively managed mutual funds-and even for passively managed mutual funds.

Since the existing high-yield ETFs are index funds, investors see them as an easy and efficient way to gain exposure to the asset class, much as they might use an ETF to represent the S&P 500 Index or US Treasuries. Thus, many investment advisors use ETFs as core holdings in their clients’ portfolios. The problem is, high-yield ETFs haven’t done a very good job of tracking benchmark indices.

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