HYGH: Best ETF In Its Category, Yet Unconvincing (NYSEARCA:HYGH) #NewsETFs

Strategy

iShares Interest Rate Hedged High Yield Bond ETF (NYSEARCA:HYGH) started investing operations on 5/27/2014 and tracks the BlackRock Interest Rate Hedged High Yield Bond Index. It has a 12-month trailing yield of 9.63% and a 30-day SEC yield of 5.99%. Distributions are paid monthly. HYGH is mostly invested in the high-yield bond benchmark iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and uses derivatives to mitigate the interest rate risk. The net expense ratio of 0.52% includes the fees of HYG, HYGH and a fee waiver.

As described by iShares in the prospectus of the main holding HYG, eligible bonds must be U.S. dollar-denominated, traded in the U.S. and issued by companies based in developed markets with a sub-investment grade average rating. Other criteria include an outstanding value of at least $400 million, an original maturity of less than 15 years and at least 1.5 years to maturity (1 year for existing constituents). Constituents are weighted based on market value, with a cap of 3% on each issuer.

Additionally, according to its own prospectus, HYGH holds interest rate swap contracts with different maturities, selected and weighted “to hedge the portfolio’s duration exposure (i.e., sensitivity to changes in interest rates) at key points on the yield curve“. Swap contracts to expire are rolled to further expiration dates on a monthly basis. The portfolio turnover rate in the most recent fiscal year was 5%.

Portfolio

HYG represents 97.7% of asset value. The remaining 2.3% of HYGH portfolio is in cash and derivatives. HYG has 1256 constituents. The top 10 issuers represent 11.8% of asset value and the top name weighs 2.4%, so the portfolio is well-diversified and risks related to individual companies are low. The heaviest sectors in the portfolio are consumer cyclicals and communication services.

About 51% of asset value is invested in debt with a BB rating; therefore the fund is focused on less risky junk bonds (BBB is investment grade).

About 47% of the assets have a maturity of between 3 and 5 years. The portfolio’s weighted average maturity is 4.05 years.

Performance

HYGH has a total return of about 50% since its inception in 2014, outperforming HYG by almost 8%. Nonetheless, the gap in annualized return is well below 1%.

The share price has lost over 15% (excluding distributions), as reported on the next chart. While it has been paying high distributions, the fund has suffered a loss in value. The decay is amplified by the cumulative inflation: about 32% since May 2014, based on CPI.

HYGH has significantly outperformed HYG in 2022 (almost 10% in one year), when the 10-year Treasury yield surged and the 10-year minus 2-year spread fell the most, as illustrated by the charts below.

The annual sum of distributions has been quite irregular in value and trend, so HYGH is not really suitable for investors seeking a stable or growing income stream (distribution depends on the swap strategy performance).

HYGH vs. competitors

The next table compares characteristics of HYGH and the two other rate-hedged high-yield bond ETFs:

• WisdomTree Interest Rate Hedged High Yield Bond Fund (HYZD)
• ProShares High Yield-Interest Rate Hedged ETF (HYHG)

Click to enlarge

HYGH is the largest and most liquid of these funds. It has the highest 4-year average yield (by a short margin) and the highest 5-year dividend growth rate. The next chart plots total returns since its inception. HYGH is the best performer, although the three funds are in a narrow range.

Takeaway

iShares Interest Rate Hedged High Yield Bond ETF (HYGH) is the largest, most liquid and best performing “junk bond” ETF hedged against interest rate variations. It has moderately underperformed the non-hedged underlying index when interest rates were staying in a range, then it widely outperformed when rates surged and the yield curve went inverted. However, keep in mind the underlying assets are junk bonds, which I have already rated as unattractive in other ETF reviews, due to a chronic decay in value and distributions. Hedging an unattractive asset category is unlikely to make it a winner in the long run.