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Junk Bond Risk Gives Actively Managed ETFs a Boost

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Two things happened Tuesday in the exchange-traded fund market for junk bonds, and while both events occurred in New York, the distant that separated them was as vast as the gulf that separates actively managed versus passively invested ETFs.

At one event, executives with AdvisorShares and one of its subadvisors, Peritus, were busy ringing the bell at the New York Stock Exchange to celebrate the success of their actively managed ETF that invests in the junk bond market. The AdvisorShares Peritus High Yield ETF (HYLD), which just turned two years old with about $200 million of assets under management, bills itself as an actively managed ETF “in an asset class that is not easily indexable.”

In an interview after the bell-ringing, AdvisorShares founder and CEO Noah Hamman said ETF investors who want to invest in the high-yield rewards of junk bonds were gravitating toward active management. And high-yield bonds, while credit sensitive, are less interest rate sensitive than 10-year Treasury notes, he said. “Any time you deal with higher risk is exactly the time you don’t want to take on a passive approach,” Hamman said. “You want to actively manage that risk.”

At the other event, over on Madison Avenue, Market Vectors officials on Tuesday were busy pulling the plug on what was supposed to be the first trading day of their Van Eck Global-sponsored ETF, Treasury-Hedged High Yield Bond ETF (THHY), which would track their index designed to provide exposure to junk bonds while using 5-year U.S. Treasury notes to hedge against rising interest rates.

Why did they pull the plug? Market Vectors, which is in a quiet period for THHY, didn’t return calls for comment. But a few things are certain: the fixed-income market is a complicated one, ETFs must jump through all kinds of hoops to meet Securities and Exchange Commission approval, and investors are finally waking up to the fact that higher interest rates wouldn’t be good for their bond investments because higher rates would mean a declining value in the price of the bonds they hold.

“I don’t know of an ETF that was set to launch and didn’t launch. Typically, ETFs announce they’re launching, and they launch,” said Todd Rosenbluth, director of ETF and mutual fund research for S&P Capital IQ ETF in a phone interview on Wednesday.

While Rosenbluth said he was unaware of THHY, he did say that he knew of several dozen ETFs in the high-yield bond space. For example, he said, just last year Market Vectors launched three such funds: the International High Yield Bond ETF (IHY), the Emerging Markets High Yield Bond ETF (HYEM) and the Fallen Angel High-Yield Bond ETF (ANGL).

Earlier this month, Market Vectors launched the BDC Income ETF (BIZD), the first-ever ETF to offer pure-play exposure to the high-yield, high-risk world of business development companies, or BDCs. Meanwhile, FINRA stated in a Jan. 11 letter to the broker-dealer firms it oversees that it was concerned about “potentially unsuitable and otherwise problematic” investments for retail investors, including BDCs.

According to a Feb. 14 ETF Trends comment by Paul Weisbruch, vice president of ETF and index sales and trading at Street One Financial, speculation has been rife lately that as yields sit near all-time lows, the strong bull run in high-yield corporate bond ETFs is due for a steeper correction — and this risk might actually give active management a boost.

Weibruch quoted Schwab analysts, who warned: “By simply buying a high yield index fund, an investor may end up with too much exposure to lower rated segments of the market. Active management allows for professional management and the ability to focus on certain segments of the market.”

To be sure, the barrier to entry into the actively managed junk ETF space is high. Winning SEC approval for sophisticated corporate credit products used in ETFs is a frustrating process, Peritus CEO and HYLD co-manager Ron Heller said in an interview Tuesday with AdvisorOne on the NYSE trading floor.

“We were in the approval stage for a year for high-yield bonds, and we’ve been waiting for approval for three years for floating-rate leveraged loans. They’re cheap, but we can’t buy them,” Heller said, noting that the SEC has held back on giving leveraged loans the OK.

Read Is 2013 the Year of Actively Managed ETFs? at AdvisorOne.