HYDB: Solid Strategy, Above Average Return 6.9%, Performance (BATS:HYDB)

The iShares High Yield Systematic Bond ETF (Bats: HYDB) focuses on high-yield corporate bonds with comparatively better quality and wider spreads. HYDB’s strategy seems to be working, with the fund having a slightly above-average 7.0% dividend yield and outperforming since inception. HYDBs a strong strategy, dividends and above-average returns make the fund a buy.

HYDB – Overview and Analysis

Strategy and Holdings

HYDB is an index ETF that focuses on high-yield corporate bonds with comparatively better quality and wider spreads. HYDB’s Core Index first selects all applicable bonds that meet a basic set of inclusion criteria. These are then screened for credit quality, taking into account seniority, balance sheet dates and market prices, among other factors. Finally, the index overweights bonds with above-average spreads for their credit qualitywhile maintaining overall credit quality. Think of HYDB as investing in the highest yielding bonds BB, then the highest yielding B-rated bonds, and so on. This is not enough right, but close enough.

HYDB is a fairly well-diversified fund with investments in over 260 bonds across the most relevant sectors. It is much less diversified than the broadest bond ETFs, including the Vanguard Total Bond Market Index Fund ETF (BND), because they invest in multiple bond sub-classes, unlike HYDB.

Credit quality

HYDB invests exclusively in non-investment grade bonds, split almost equally between BBB and BB holdings, with smaller allocations to CCC and CC.

HYDB index should ensure a credit quality profile similar to that of its (broader) benchmark. Since most high yield bond benchmarks are similar, this should result in similar credit quality to the largest high yield bond index ETFs. HYDB credit quality is easy HIGH than that of the iShares Broad USD High Yield Corporate Bond ETF (USHY), the largest index ETF in this space. The results are easy better than expectations, although the differences here are not significant.

HYDB’s poor credit quality should result in significant, above-average losses during recessions and downturns. Losses could be slightly lower than those of broader high yield bond ETFs due to differences in credit quality, but these are very small differences and could be easily affected by other factors or volatility.

HYDB suffered double-digit losses in early 2020 at the onset of the coronavirus pandemic, in line with the above. Losses were marginally lower than those of its benchmark, but the differences here are small and almost certainly nose-bleeding.

Dividend yield

Riskier bonds tend to have higher yields, and HYDB bonds are no exception. The fund itself has a yield of 6.9%, slightly higher than most bonds and bond subasset classes. Of the larger of these, only senior loans have higher yields. Some of the more niche income assets have significantly higher yields than HYDB, including mREITs and BDCs.

The HYBD index should result in a higher return than most of the fund’s high-yield bond peers, which indeed it does. Among the larger ETFs in this space, only the SPDR Portfolio High Yield Bond ETF ( SPHY ) has a higher yield.

HYDB’s strong, above-average dividend yield of 6.9% benefits the fund and its shareholders. That’s an especially important benefit given that both HYBD’s dividends and credit quality are higher than those of its high-yield bond peers. High-return, low-risk investments are rare, but HYDB appears to be (marginally) one.

Performance Track-Record

HYDB’s track record is quite strong, with the fund outperforming most bonds and bond sub-asset classes since inception and for most relevant time periods. The outperformance was due to a combination of higher yield and lower duration

As is the case with most bond ETFs, HYDB’s 3-year returns are particularly poor as they coincide with a period of rising rates / lower bond prices. Yields over the past twelve months have been incredibly strong as rates have softened but remain at elevated levels. Long-term yields in the 5.0% – 6.0% range seem reasonable, although they depend heavily on future Fed policy.

More importantly, HYDB has outperformed most of its peers since inception, and reasonably consistently. It has underperformed over the past three months, but only slightly, and the results could simply have been due to volatility.

In my opinion, HYDB’s outperformance was due to the fund’s above-average return and overall successful strategy. Focusing on relatively higher yielding bonds while keeping credit quality constant should result in higher yields, as appears to be the case.

Small inefficiencies like these are common in fixed income markets, with fallen angels, bonds recently downgraded from investment grade to non-investment grade, being a particularly prominent example. HYDB probably invests heavily in these and the fund has largely matched its performance since inception.

Blackrock has a similar ETF that focuses on investment grade bonds. The said ETF has also outperformed since inception, further proof of the effectiveness of these strategies.

Overall, I think the HYDB strategy is working. Makes sense in theory. It results in slightly higher yields and credit quality. The performance was pretty good from the start, with few exceptions. A similar fund also outperformed.

Conclusion

HYDB focuses on high yield corporate bonds with comparatively better quality and wider spreads. The HYDB strategy works in theory and has worked in practice, resulting in higher returns and higher performance from the start.