7 Best Junk Bond ETFs Of May 2024

The iShares Fallen Angels USD Bond ETF tracks an index composed of U.S. dollar-denominated, high-yield corporate bonds that have lost their previous investment-grade rating.

Here’s why that focus on “fallen angels” is a good thing: It gives FALN a shot at price appreciation. How? Many other investors sell fallen angels simply because those bonds were downgraded, not necessarily because of flaws in their financial fundamentals. That means FALN can buy them at relatively bargain prices. Later, if they are upgraded back to investment-grade, they’ll likely rebound in price.

In addition, FALN has another tactic for controlling risk. FALN targets a segment of the high-yield market that has typically demonstrated higher credit quality than the broader high-yield market. And FALN’s pursuit of high-yield debt means it is suitable for shareholders seeking income. Income plus a focus on higher credit quality are especially reassuring in a volatile market like the current one.

The SPDR Bloomberg Short-Term High Yield Bond ETF seeks to provide results that track the performance of the Bloomberg US High Yield 350mn Cash Pay 0-5 Yr 2% Capped Index.

The fund invests in fixed-rate, short-term, U.S.-dollar-denominated, high-yield corporate bonds with maturities of less than five years. Their sub-investment-grade ratings range between Caa3 and Ba1 by Moody’s and between CCC- and BB+ by S&P or Fitch.

SJNK’s under five-year maturity cap means the portfolio has lower interest-rate risk than ETFs composed of longer bonds. About 60% of holdings have maturities of three to five years. Approximately 25% have maturities of two to three years. That’s good at a time when the Federal Reserve is still raising rates to tame inflation.

In terms of duration, SJNK has an average effective duration of a little more than two years. That’s lower than its high-yield bond fund peer group’s average effective duration exceeding three years. Effective duration shows the expected price decline of a bond or bond fund for each 1% rise in interest rates. In SJNK’s case, shareholders can expect the security to fall in value by just 2.35% for each 1% rise in interest rates.

Credit quality presents higher risk in the current environment. Less than 2% of the portfolio has an investment-grade rating.

An outstanding dividend yield makes SPDR Portfolio High Yield Bond ETF the most generous income provider of the ETFs on our list. Meanwhile, SPHY’s bargain-basement annual expense ratio makes it the least expensive entry on the list. Its annual fee is approximately one-eighteenth of its peer group’s average.

SPHY tracks the ICE BofA US High Yield Index of U.S. corporate debt, and more than 98% of its holdings are junk bonds. Its largest weighting is to the consumer discretionary sector. SPHY’s next largest sources of bonds are the communications, energy and consumer defensive sectors.

Around 49% of the fund’s bond holdings have maturities of one to five years. Another 46% have maturities of five to 10 years. The fund has an average effective duration of about 3.5 years.

In addition to measuring a bond or fund’s vulnerability to interest-rate increases, duration reflects the time it takes an investor to recover the true cost of a bond, including its coupons and any call features. At a time when rates are climbing, investors are worried about locking up their money for long periods. That’s why long bonds–let’s say bonds that mature in 10 years or longer–have lost so much value in the past year.

SPHY’s duration is a tad higher than its peer group, but still relatively short. That makes the fund fairly well-suited for the current rising interest-rate environment.

The iShares Inflation Hedged High Yield Bond ETF is an outlier among our picks. The expense ratio is the highest on this list, although it is well below the average for the fund’s peer group.

So what do we see in HYGI? The fund is designed to manage inflation risk while seeking income from high-yield bonds. That addresses a vital need amid an inflationary environment.

About 96% of the fund’s portfolio consists of another BlackRock-run fund, iShares iBoxx $ High Yield Corporate Bond ETF (HYG). The rest is in cash and derivatives in U.S. dollar-denominated high-yield corporate bonds. Those derivatives include a lot of what Wall Street pros call inflation swaps, which entail extra costs. The fund’s relatively pricey expense ratio is due largely to a good cause: Hedging for inflation risk.

In fact, HYGI aims to track the performance of the BlackRock Inflation Hedged High Yield Bond Index. That in itself is to control HYGI’s inflation risk.

Nearly 90% of HYGI bonds are rated BB or lower, all below investment grade. Still, HYGI has an average effective duration of about 3.5 years. The lower that number is, the less the fund is at risk from rising rates, giving this fund a protective suit of armor in at a time when interest rates are still high and likely still rising.

With around 2,000 holdings, iShares Broad USD High Yield Corporate Bond ETF offers broader high-yield market exposure than almost any other fund, and it does it at a low cost. This fund is designed to complement core fixed-income investments, with the goal of enhancing portfolio income and appreciation.

USHY’s holdings are dollar-denominated corporate high-yield bonds. The fund adds diversification by including issues from so-called FX-G10 countries, home to 10 of the most heavily traded currencies in the world. In addition to the U.S. and its territories, their home markets include the Eurozone, the U.K., Norway, Sweden, Switzerland, Australia, Canada, Japan and New Zealand.

USHY’s average effective duration, which shows how vulnerable the fund is to rising interest rates, is less than four years. That is slightly higher than most of our other recommendations, but still low enough to be helpful in a rising rate environment.

The iShares 0-5 Year High Yield Corporate Bond ETF is designed for periods when the Fed is attacking inflation by raising interest rates.

SHYG does that by focusing on corporate bonds with remaining maturities of less than five years. That shorter end of the bond-maturity spectrum is hurt less by rising rates than the longer end. On the longer end, bonds become increasingly less valuable as rates rise—and investors industry-wide could be stuck with that debt for a longer time. Investors typically react by selling off those longer bonds.

Remember, that was the root cause of difficulties for some banks recently that held too many longer bonds. Their bonds kept falling in value.

SHYG also avoids putting too many eggs in one basket. The benchmark it’s based on, Markit iBoxx USD Liquid High Yield 0-5 Index, caps individual holdings at 3% weightings in its portfolio. Further, the fund’s dividend yield is in line with other ETFs in our list.

The iShares US and International HY Corporate Bond ETF invests in fixed income from developed markets around the world. Its corporate bonds are denominated in these local currencies: U.S. dollars, euros, British pounds sterling and Canadian dollars.

That’s good insurance against the inevitable day when the U.S. dollar stops its current climb and begins to slide back down to earth. “Investing in non-U.S.-dollar bonds helps protect against a weakening dollar,” says Bryan Armour, director of passive strategies research, North America, for Morningstar Research Services. “If you buy a bond denominated in Canadian dollars, for example, and the Canadian dollar strengthens versus the U.S. dollar, then that income stream/return of principal will be able to buy more U.S. dollars when translated back to U.S. dollars.”

GHYG holds bonds with maturities between one and a half and 15 years. Those high-yield bonds are rated BB+ or below by S&P and Fitch and Ba1 and below by Moody’s. That’s junk-bond territory.

GHYG is yet another option for investing in a short-duration ETF (about 3.5 years) that also offers greater diversification. The fund offers exposure to local currency-denominated high-yield corporate bonds issued by companies from around the world, which adds an element of geographic diversification to a portfolio.