Latest views - inflation       |       Latest views - China       |       Listen - Investment podcast series       |       Find our latest research


Launched in 2002, fixed income exchange-traded funds (ETFs) have become an increasingly popular option with investors. However, as we have previously noted,1 in certain areas, such as high yield, ETFs have struggled to replicate benchmark returns. In this article, we revisit that comparison, taking into account the volatility witnessed in 2020, to see whether our concerns remain valid.


Figure 1. Gross of fee ETF returns versus Broad Benchmark and Active High Yield Universe

Returns

ETFs (HYG & JNK)

Broad
High Yield Index

Median Active
High Yield Universe

2016

14.6%

17.2%

14.5%

2017

6.6%

7.5%

7.8%

2018

-2.3%

-2.2%

-2.1%

2019

14.9%

14.3%

14.4%

2020

4.6%

7.1%

6.9%

5-Year

7.5%

8.6%

8.1%

Index: Bloomberg Barclays US Corporate High Yield Index; Source: MercerInsight®
Median Active High Yield Universe; Source: MercerInsight®
High Yield ETF Source: BlackRock, State Street

The returns in the table show that ETFs have underperformed the broad-based high yield index in four of the past five years. In 2020, over the full year, the major high yield ETFs, HYG and JNK substantially lagged during a market inflection point. This happened despite the Federal Reserve announcing support for the sector in April. As shown by the median active high yield universe returns, investors would likely have benefited from allocating to an active high yield portfolio. 
 

Compared to a traditional active strategy, high yield ETFs have two important distinctions. First, most high yield ETFs do not attempt to replicate the broad-based index used by active funds. This includes HYG and JNK. Instead, they aim to replicate a more liquid slice of the high yield market. Second, most high yield ETFs utilize a passive management approach that aims to replicate the index by purchasing a representative portfolio of bonds, rather than every issue, to help reduce transaction costs.
 

The performance of institutional high yield passive options serves as a good comparison. Despite coming from the same providers, returns typically improved compared to ETF options. Given that ETFs have daily liquidity and need to continually rebalance to match the index, improved performance for institutional passive vehicles was likely achieved due to the lower amount of flows. Crucially, these characteristics can allow institutional passive vehicle to target a more representative index for high yield.
 

An additional performance drags come from transaction costs and fees. Fees for the major high yield ETFs, HYG and JNK, are 49 bps and 40 bps,[1] respectively; while fees for the median fee for an actively managed high yield separate account and an institutional mutual fund is 48 bps and 68 bps,[2] respectively. This may surprise some investors who are used to passive ETFs being low cost, such as in equities (3 bps) or investment grade fixed income (4 bps). For comparison, institutional commingled passive options in high yield run around 15 bps.
 

Conclusion

In our opinion, active management still holds an advantage over passive ETF investing and is the most prudent way to gain high yield exposure. We believe there are inherent benefits in high yield active management due to the market complexity and issuer level idiosyncratic factors that exist within leveraged credit. Active strategies can underweight sectors/issuers in which there are identifiable secular challenges or economic uncertainty, while overweighting sectors/issuers with a high probability for more stable cash flows. Although achieving alpha in high yield can be challenging, investors should be aware that they would be unlikely to capture the index return passively through ETFs or even institutional passive commingled funds. However, if an investor prefers a passive approach, we believe that they can benefit from using an institutional comingled or separately managed vehicle in which the manager can better control the flows and likely have lower fees.

 

1 Source: BlackRock and State Street; as of 3/31/2021

2 Source: MercerInsight®; Universe: US High Yield; As of 3/31/2021

 

Daniel Natale 

Fixed Income Specialist

Connect with us

  • Important Notices

    References to Mercer shall be construed to include Mercer LLC and/or its associated companies.

    © 2021 Mercer LLC. All rights reserved.

    This contains confidential and proprietary information of Mercer and is intended for the exclusive use of the parties to whom it was provided by Mercer.

    This content may not be modified, sold or otherwise provided, in whole or in part, to any other person or entity without Mercer's prior written permission.

    Mercer does not provide tax or legal advice. You should contact your tax advisor, accountant and/or attorney before making any decisions with tax or legal implications.

    This does not constitute an offer to purchase or sell any securities.

    The findings, ratings and/or opinions expressed herein are the intellectual property of Mercer and are subject to change without notice. They are not intended to convey any guarantees as to the future performance of the investment products, asset classes or capital markets discussed.

    For Mercer’s conflict of interest disclosures, contact your Mercer representative or see http://www.mercer.com/conflictsofinterest.

    This does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances. Mercer provides recommendations based on the particular client's circumstances, investment objectives and needs. As such, investment results will vary and actual results may differ materially.

    Information contained herein may have been obtained from a range of third party sources. While the information is believed to be reliable, Mercer has not sought to verify it independently. As such, Mercer makes no representations or warranties as to the accuracy of the information presented and takes no responsibility or liability (including for indirect, consequential, or incidental damages) for any error, omission or inaccuracy in the data supplied by any third party.

    Past performance is no guarantee of future results. The value of investments can go down as well as up, and you may not get back the amount you have invested. Investments denominated in a foreign currency will fluctuate with the value of the currency. Certain investments, such as securities issued by small capitalization, foreign and emerging market issuers, real property, and illiquid, leveraged or high-yield funds, carry additional risks that should be considered before choosing an investment manager or making an investment decision.

    Not all services mentioned are available in all jurisdictions. Please contact your Mercer representative for more information.

    Certain regulated services in Europe are provided by Mercer Global Investments Europe Limited and Mercer Limited.

    Mercer Global Investments Europe Limited and Mercer Limited are regulated by the Central Bank of Ireland under the European Union (Markets in Financial Instruments) Regulation 2017, as an investment firm. Registered officer: Charlotte House, Charlemont Street, Dublin 2, Ireland. Registered in Ireland No. 416688. Mercer Limited is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 984275. Registered Office: 1 Tower Place West, Tower Place, London EC3R 5BU.

    Investment management services for Canadian investors are provided by Mercer Global Investments Canada Limited. Investment consulting services for Canadian investors are provided by Mercer (Canada) Limited.

    Investment management and advisory services for U.S. clients are provided by Mercer Investments LLC (Mercer Investments). Mercer Investments LLC is registered to do business as “Mercer Investment Advisers LLC” in the following states: Arizona, California, Florida, Illinois, Kentucky, New Jersey, North Carolina, Oklahoma, Pennsylvania, Texas, and West Virginia; as “Mercer Investments LLC (Delaware)” in Georgia; as “Mercer Investments LLC of Delaware” in Louisiana; and “Mercer Investments LLC, a limited liability company of Delaware” in Oregon. Mercer Investments LLC is a federally registered investment adviser under the Investment Advisers Act of 1940, as amended. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Mercer Investments’ Form ADV Part 2A & 2B can be obtained by written request directed to:  Compliance Department, Mercer Investments 99 High Street, Boston, MA 02110.