With interest rate cuts expected from the Federal Reserve, investors may need to look to riskier parts of the bond market to keep income levels stable. Columbia Threadneedle is one firm that thinks the high-yield sector of the bond market is where active management can make a difference. The firm on Thursday launched two high-yield ETFs targeting different segments of the high-yield market: the Columbia US High-Yield ETF (NJNK) and the Columbia Short-Term High-Yield ETF (HYSD). Marc Zeitoun, head of North American product and business intelligence at Columbia Threadneedle, said he believes investors should always have exposure to high yield, but there may be more appetite for investors as the Federal Reserve is expected to cut interest rates. The Fed fund futures market suggests traders expect a 25 basis point, or 0.25%, rate cut next week and more cuts by the end of the year, according to the CME FedWatch tool. “Cultures can go up and down and markets can price it, but clients who need income can’t afford it,” Zeitoun said. High-Yield Case So far this year, high-yield debt has outperformed the bond market as a whole. The largest high-yield index ETF, the iShares Broad USD High Yield Corporate Bond ETF ( USHY ), has returned 7.2% year to date, compared with 4.9% for the firm’s Core US Aggregate Bond ETF ( AGG ). Columbia’s new funds are more expensive than USHY, but fees are roughly in line with some of the other popular high-yield ETFs. Corporate bond yields are usually determined relative to a risk-free benchmark, with riskier or “junk bonds” earning the highest returns. But the gap between the risk-free interest rate and high yield levels is not constant over time or from one bond issue to another. Currently, spreads between Treasurys and risky bonds are abnormally low. Dan DeYoung, one of NJNK’s managers, said the market is assuming a default rate of about 1%, which Columbia Threadneedle considers too optimistic. “Over the last 12 months, we’ve been pretty close to bottom spreads… It just tells us that the implied default expectations, at least in terms of spreads, are pretty low, when in fact our expectation is that they’re probably going to be somewhere in the 3% range,” he said. DeYoung. NJNK is a rules-based fund with an active component. The goal is to avoid the riskier ‘tail’ of the high-yield market, which gives investors a very strong current return with the potential to benefit from falling rates. the more time you choose,” DeYoung told NJNK. The Columbia Threadneedle funds are new and have no track record. However, DeYoung is also the manager of the Columbia High-Yield Bond (CHYZX) mutual fund, which has a four-star rating from Morningstar. High returns when rates fall Market the price of long-term bonds tends to rise when interest rates fall because those bonds offer sensitivity to interest rates expressed as a longer term or time dimension. However, there are some wrinkles to this outlook that emerge when focusing on high-yield bonds. Because long-term investments have a lot of value based on distant cash flows, a weakening economy that prompts widespread fear of default can cause spreads to widen, meaning quoted yields on bonds stay the same or even go higher. Fed cuts interest rates. This feature suggests that a high-yield fund can underperform other bond funds, especially on a price basis, during a period of interest rate cuts. Chris Keller, one of HYSD’s short-term managers, said the short-term high-yield market can therefore outperform the group as a whole during economic downturns, but that doesn’t eliminate the risk. default. “Preventing credit losses is more important because there is less opportunity to offset them within other investments or to reduce the ones with price increases. And that’s why we take a completely active approach in the short term, backed by a strict bottom-up credit research approach. Keller said. Columbia Threadneedle isn’t the only fund launching high-yield funds this year. Some other recent examples include the BlackRock High Yield ETF ( BRHY ) and the EU Short Term High Yield ETF ( SYFI ).
