iShares has launched the first global high-yield bond exchange traded fund (ETF) to be listed on the London Stock Exchange. The iShares Global High Yield Bond ETF (HYLD) tracks the Markit iBoxx Global Developed Markets Liquid High Yield Capped Index by investing directly in the underlying bonds. It offers an attractive yield of more than 6 per cent and will distribute dividends twice a year, with a total expense ratio (TER) of only 0.5 per cent.
In the current low-yield environment and following a surprise rise in UK inflation in October, high-yield bonds continue to be of interest to investors willing to take on the extra corporate credit risk offered by sub-investment-grade issuers.
Markit iBoxx Global Developed Markets Liquid High Yield Capped Index aims to provide a balanced representation of the global developed high-yield corporate market by the means of the most liquid high-yield corporate bonds available. The maximum original time to maturity for bonds in the index is 15 years, and the minimum time to maturity is one-and-a-half years for new bonds, and one year for bonds already in the index. For diversification purposes the weight of each issuer in the index is capped at 3 per cent.
The bonds are issued by companies in developed markets but rated below investment grade (triple B) so considered more likely to default than investment-grade bonds. They can also be more volatile, but tend to pay a much higher interest rate, known as the coupon, to their investors. They are denominated in Canadian dollars, euros, Sterling and US dollars.
The launch comes as State Street launches its SPDR BofA Merrill Lynch Emerging Markets Corporate Bond UCITS ETF (EMCB), which tracks investment-grade and high-yield emerging market corporate debt, denominated in US dollars. It tracks the BofA Merrill Lynch Emerging Markets Diversified Corporate ex-144a Index, which comprises around 579 bonds from 230 issuers with a minimum rating of CCC. Emerging market corporate bonds can offer investors attractive yield opportunities (this index has a yield to maturity of 4.1 per cent) in comparison to some developed corporate bonds, while retaining the liquidity benefits of hard currency US dollar issuance.
SPDR BofA Merrill Lynch Emerging Markets Corporate Bond UCITS ETF will also distribute dividends twice a year and has a TER of 0.5 per cent.
The Markit iBoxx Global Developed Markets Liquid High Yield Capped Index comprises around 8,000 bonds, but iShares Global High Yield Bond ETF only has 301 bonds as it is managed using optimisation, a sampling technique that provides exposure to the performance of the index. The ETF may also hold some securities that are not in the benchmark index if they provide similar performance and have a matching risk profile to certain securities that make up the benchmark. To ensure diversification, no single issuer accounts for more than 3 per cent of the fund.
SPDR BofA Merrill Lynch Emerging Markets Corporate Bond UCITS ETF, meanwhile, tracks an index with around 579 bonds but currently holds around 95.
Because optimising funds are not the same as the index, iShares says there is a risk that their returns will not track those of the benchmark. ETFs don't usually exactly replicate the indices they track because of their costs, so always underperform by a little. But optimisation adds another potential reason for the fund not to track accurately.
However, iShares also says that optimisation reduces trading costs and volatility, resulting in closer tracking of the index, and its track record is testament to the success of this approach. Buying all 8,000 bonds in the index would incur tremendous trading costs so that the ETF could not have a low charge of 0.5 per cent. More esoteric bonds such as high-yield ones can also be harder to buy and sell, so it might not be so easy or cheap for the ETF to get hold of these, or sell them when necessary.
iShares also aims to build up the number of holdings as its bond funds grow so that eventually they hold all, or nearly all, the holdings in the index. It also closely matches the risk characteristics of its ETFs to the index, for example, to get the same yield, maturity, duration, country and sector allocation.
Constructing a fund like this could be said to be more like active management. However, Peter Sleep, senior portfolio manager at Seven Investment Management, argues that optimisation is still a case of balancing tracking with cost, whereas active management is a judgment call.
Synthetic ETFs, which get their returns via a swap, have been criticised for holding collateral that does not resemble the index they track. However, an optimised ETF with only a small sample of securities in a given index, and perhaps some that are not in the index, is also different to its index.
However, physical providers argue that they still hold a sample basket of the index they track, whereas a synthetic ETF tracking the FTSE 100, for example, could hold Japanese equities. Although its ETFs can in theory hold non-index bonds, iShares says this is a short-term measure - to match a maturity profile, for example - and does not happen often, or in all its funds.
View the IC fund tips
Visit our funds and ETFs page for fund profiles, interviews with fund managers and the latest fund news
View our top 100 funds list