As the Federal Reserve hints at an upcoming interest rate cut, investors are looking at different ways to keep income steady in a changing market. High-yield bonds, often called “junk bonds” because of their higher risk, are catching the eye of those willing to take on more risk for the chance of higher returns. Columbia Threadneedle, a well-known investment firm, is responding to this trend by launching two new high-yield exchange-traded funds (ETFs): the Columbia U.S. High Yield ETF (NJNK) and the Columbia Short Duration High Yield ETF (HYSD). These ETFs aim to help investors manage the expected interest rate cuts while giving access to various parts of the high-yield market.
Marc Zeitoun, who leads North American product and business intelligence at Columbia Threadneedle, stresses the importance of having some exposure to high-yield bonds, especially with the Federal Reserve likely to lower rates. According to the CME FedWatch tool, a 0.25% rate cut is expected, with more cuts likely before the end of the year. In this kind of setting, investors looking for steady income might need to think about options beyond the usual, safer assets. “Interest rates can change, but those who rely on income can’t handle instability,” Zeitoun notes, pointing out the challenge that rate changes present for income-focused investors.
High-yield bonds have already done well in 2024, beating the broader bond market. For instance, the iShares Broad USD High Yield Corporate Bond ETF (USHY) has gained 7.2% so far this year, surpassing the 4.9% return of the Core U.S. Aggregate Bond ETF (AGG). While Columbia Threadneedle’s new ETFs have higher fees than USHY, they are competitively priced against other high-yield funds. NJNK has an expense ratio of 0.46%, with HYSD slightly lower at 0.44%, reflecting the firm’s commitment to actively managing the fund to find better-quality bonds.
The pricing of high-yield bonds generally shows their risk compared to U.S. Treasurys, with the “spread” between the yields showing how the market views the risk of default. Right now, these spreads are unusually small, suggesting the market is optimistic about defaults. However, Dan DeYoung, who manages NJNK, warns that the market’s 1% default rate expectation might be too optimistic. Columbia Threadneedle expects a higher default rate, closer to 3%, indicating more risk than the market currently assumes.
NJNK uses a mix of a rules-based approach and active management to avoid the riskiest high-yield bonds, focusing on getting more exposure to higher-quality bonds. DeYoung explains that this strategy aims to provide strong income potential while also benefiting from falling interest rates. “Our focus is on the best options within high yield,” he says, emphasizing the fund’s goal of securing income without taking on too much risk. The active management approach allows NJNK to adapt to changing market conditions, giving it an edge over passive high-yield ETFs.
For those worried about defaults or economic downturns, the short-duration, high-yield bond market offers another option. These bonds are less sensitive to interest rate changes and can potentially do better than longer-term bonds during uncertain times. Kris Keller, a manager for HYSD, notes that while there are risks, the lower interest rate sensitivity of short-duration high-yield bonds can offer more stability in rough markets. “Avoiding credit losses is crucial,” Keller points out, stressing the need for careful analysis to steer clear of riskier issuers while still aiming for high yields.
Columbia Threadneedle’s move into this market comes as other big asset managers, like BlackRock and AB, are also launching new high-yield bond funds. This increased activity in the high-yield sector shows growing interest as investors look for ways to maintain income in a possibly lower-rate environment.
However, high-yield bonds come with unique risks, especially when rates are being cut. While falling rates usually lead to higher bond prices, high-yield bonds are still at risk of default, which can go up during economic downturns. If defaults rise, the spread between high-yield bonds and Treasurys could widen, keeping yields high but limiting price gains and potentially leading to underperformance for some funds.
In short, while high-yield bonds offer attractive income opportunities, investing in this market requires careful planning. Columbia Threadneedle’s focus on active management aims to address the specific risks of the sector by picking higher-quality bonds and minimizing credit losses. As the Federal Reserve moves toward cutting rates, high-yield bonds could play an important role in keeping income steady—if managed with a careful understanding of both the risks and potential rewards.
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