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ETF Specialist

Only the Highest Quality Junk (Bonds)

This ETF follows a rules-based index that avoids the lowest-rated junk bonds.

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Unlike traditional bond indexes, which typically give higher weightings to issuers with the greatest amount of debt,  PowerShares Fundamental High Yield Corporate Bond Index's (PHB) index-weights its holdings according to fundamental measures of issuers' size, including sales, cash flow, dividends, and the book value of their assets.

This, along with the rules-based benchmark's exclusion of any bonds rated CCC or lower, results in a portfolio of junk bonds with a relatively smaller allocation to the riskiest issuers compared with its market-cap-weighted peers. Cap-weighted exchange-traded funds  iShares iBoxx $ High Yield Corporate Bond (HYG) and  SPDR Barclays High Yield Bond (JNK) have 10% and 14% of their portfolio in bonds rated CCC or lower, respectively. As such, this fund may fit the bill for investors looking for a less aggressive high-yield option. However, a potential drawback of the fund's higher-turnover strategy, which tilts away from the largest issuers, is that higher transaction costs may lead to greater tracking error, as has been the case historically.

John Gabriel does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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