designer491
Introduction
The SPDR® Portfolio High Yield Bond ETF (NYSEARCA:SPHY) (the “Fund”) is a large (more than $3.5 billion in assets), highly diversified, high yield exchange-traded fund (“ETF“). I have a negative view of this Fund and do not believe investors are rightly compensated for the risk.
In short, I am bearish on the Fund relative to other investment options, and for the reasons provided herein, believe the Fund to be a SELL.
Fund Basics
Per the Fund’s fact sheet (the “Fact Sheet”), the Fund seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the ICE BofA US High Yield Index (the “Index“). At a very low cost (only 0.05% management fee), the Fund offers exposure to over a trillion dollars of USD-denominated high yield debt, and it tracks the index very well.
As of February 15, 2024, per Seeking Alpha data, the Fund yields roughly 7.50%.
Performance
Since its inception on June 12, 2012, through January 31, 2024, the Fund’s performance was 4.51% per annum. Notably, that is before taxes!
Performance over the 10, 5, 3 and 1-year periods (as of January 31, 2024) was as follows (see the Fund website link in the prior paragraph):
| 1 Yr. | 3 Yr. | 5 Yr. | 10 Yr. | |
| NAV | 9.36% | 2.20% | 4.58% | 4.26& |
| Market Value | 9.14 | 2.23 | 4.02 | 4.34 |
| Returns After Taxes | 6.07 | 0.37 | 2.51 | 2.06 |
Overall, the returns of this highly diversified Fund (nearly 1,900 holdings) are not inspiring.
Per the Fund website, the Index includes publicly issued high yield bonds (bonds with a below investment grade rating), “at least 18 months to final maturity at the time of issuance, at least one year to maturity, a fixed coupon, and a minimum amount outstanding of $250 million.”
SECTOR WEIGHTINGS
Top Sectors of the Fund are as follows:
Consumer Cyclical 19.10%
Communications 15.00%
Energy 12.18%
Consumer Non-Cyclical 11.54%
Capital Goods 10.69%
Technology 7.67%
Basic Industry 5.25%
Source: Fund Fact Sheet (linked above)
In terms of the quality of the Fund’s portfolio (the “Portfolio“), per the Fact Sheet:
1.04% of the Portfolio is investment grade (i.e., BBB- or higher),
45.45% of the Portfolio is rated BB,
40.34% of the Portfolio is rated B,
12.41% of the Portfolio is rated CCC or Lower, and
less than 1% of the Portfolio is not rated.
The Bear Theses
The reasons I am bearish on the Fund are described below.
As shown above, fund performance has been modest since inception and any period longer than a year. Moreover, federal income taxes materially diminish the Fund’s investment returns. If the Trump tax cuts are allowed to expire after 2025, then an even higher percentage of the Fund’s gains will be subject to federal income taxation. For U.S. investors, if you live in a high tax State like California, forgot about it. Frankly, I do not think the Fund is appropriate for taxable accounts.
The returns described above are even worse on an inflation adjusted basis; as such, after taxes and inflation, I don’t think investors are being compensated for the risks they are taking in the high yield market. Some of those risks might be around the corner.
The so-called “maturity wall” (companies needing to refinance in the next couple of years) has been growing so there is the potential for volatility as the window for junk borrowers to delay refinancing shrinks. According to S&P Global:
[E]scalating maturities in coming years include a growing concentration of speculative-grade (rated ‘BB+’ or below) debt. And as [junk] borrowers seek to refinance this looming debt, it will increase pressure on financing conditions, as demand for funding will rise. Furthermore, even though interest rate cuts are expected to begin later this year, borrowers face higher costs of funding for fixed-rate debt that was originally issued when rates were lower. In the meantime, borrowers with floating-rate debt (which accounts for just over half of speculative-grade [junk] debt) are already adjusting to the higher funding cost environment.”
[Emphasis supplied.]
To put a figure to the phenomenon, according to Simplify Asset Management, “at 4.89 years, the weighted average maturity of the high yield credit market is the lowest in history.”
Too much supply of high yield debt, should (according to microeconomics) cause the cost of that debt to rise, and it may do so materially. The “maturity wall” does not bode well for the performance of the Fund and high yield debt in general on a going forward basis.
With inflation being sticky, and Federal government spending out of control, the Treasury market could be in trouble. Over the next couple of years, my base case is that purchasers of Treasuries will require a higher level of return to compensate for the growing uncertainty associated without of control U.S. debt, sticky inflation, global conflict, U.S. internal polarization, the weaponization of natural resource and the U.S. dollar, etc.
All things being equal, higher yields on Treasuries will be negative for the junk bond market.
Finally, prospects for high yield bonds remain dependent on the unfolding economic data. The lagged impact of the Fed’s monetary tightening cycle could still cause a growth scare. In this regard, the data with respect to January 2024 retail sales was not positive. A growth scare, or even an outright recession, will not be positive for junk bonds.
Where Could I Go Wrong?
Of course, my bearishness on the Fund does not mean my view will win out in the end. For one, it is possible that the factors I have referenced above are already fully priced in to the junk bond market. Second, the employment numbers continue to be strong, mitigating against arguments for a recession or growth slowdown. Third, aggressive interest rate cuts by the Federal Reserve, ending quantitative tightening and/or re-starting quantitative easing could each (on their own or in the aggregate) be supportive of the junk bond market. Finally, the excessive spending by the Federal Government continues to support the economy and such spending is not likely to end any time soon — this is broadly supportive of the high yield market and I can certainly envision a scenario where some of that spending is targeted at the bailout of certain industries, including commercial real estate.
Risks
Among other risks included herein and in the prospectus, certain risks associated with ownership of shares of the Fund are set forth below:
Default Risk: High yield bonds are issued by companies with lower credit ratings, indicating a higher risk of default.
Market Liquidity: The market for high yield bonds may be less liquid compared to that of investment-grade bonds. In times of market stress, liquidity can dry up (and the resulting draw-downs can be material).
Economic Sensitivity: High yield bonds are more sensitive to economic conditions than investment-grade bonds. Economic downturns or recessions will increase the risk of defaults.
Spread Risk: Changes in credit spreads (the difference between yields on high yield bonds and Treasury bonds) can affect the performance of high yield funds. As noted above, rising interest rates will lead to higher borrowing costs for high yield debt issuers, affecting their ability to service their debt.
Market Timing Challenges: Successfully timing the entry and exit points in the high yield market can be challenging.
Conclusion
For the reasons enumerated above, I am bearish on the Fund.
At this stage in the cycle, if I am going to invest in junk debt, it is going to be a single issue special situation (with asymmetric upside), not a diversified product that guarantees mediocrity or worse.
Until the yield on the Fund begins to approach 10%, count me disinterested, particularly when, at the time of writing, I can collect nearly 5.40% in short term treasury bonds.
