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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.

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