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ETF Specialist

Are High-Yield ETFs Junk?

The high-yield bond market poses unique challenges to index funds that make an active approach more attractive.

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The high-yield bond market is not very conducive to index investing. High-yield bonds are expensive to trade and more likely to be mispriced than more heavily traded securities in less-fragmented markets.

The high-yield bond indexes underlying the largest exchange-traded funds attempt to work around the liquidity challenges of this market by sticking to the largest and most heavily traded bonds and weighting them by market capitalization. This approach pulls them toward the most heavily indebted issuers, which can increase the risk and make them less representa­tive of their active peers than stock index funds. Additionally, the typical high-yield bond index fund doesn’t enjoy as large of a cost advantage over its actively managed peers as counterparts in many other catego­ries. All these factors diminish the appeal of indexing high-yield bonds.

Alex Bryan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.