Fallen Angels vs. Hedged High Yield — Bond ETF Smackdown!

Three bond ETFs walk into portfolio.

One's chasing downgraded debt.

Another one is hedging interest rate risk like it's 2022.

And yet another is a hoham corporate type.

And that's what we have on today's ETF battles.

Today's audience requested triple header between these three bond ETFs.

Couldn't be more different.

And yet they all claim a seat at the fixed income table.

So which is the optimal choice?

Stick around for the answer. >> >> You're watching ETF Battles.

I'm Ronda Ley.

Great to see you again.

If it's your first time joining us, welcome to our community.

Be sure to hit that subscribe button and don't forget to participate with your comments as well as your ETF battle requests.

Give us your ticker symbols in the comment section below.

Be sure to check out our season 6 playlist to make sure that your desired matchup has not already been done.

I'm also excited to announce we just launched two free online courses, habits of the investing great and retire securely.

Both of these courses are absolutely free to all of our viewers.

So, hit the description section below uh for the enrollment rink link.

Also, we've got in that same area links to our program sponsor direction.

Besides leverage and inverse choices on broad market indexes, there's lots of choices for ETFs linked to industry sectors along with MAG7 and single stocks like Nvidia, Palanteer, Tesla, and many others.

So again, hit that description section below or you can also just go straight to direction.com.

So today's ETF contest was requested by a viewer named The Great O 360 and it's a bond matchup between Black Rockck Van and Vanguard.

All of these ETFs are very different uh bond strategies behind them.

And to help you just appreciate how long this viewer has been thinking about today's ETF battle, they actually did an edited uh request from an original post that was over two years ago.

Wow, that's some serious deliberation, not to be confused with procrastination.

Thank you, O 360, the great O 360 for today's ETF contest.

Your deliberation is about to be rewarded.

Joining us, we've got a dual extraordinaire.

We've got Tony Dong, an independent ETF analyst, and Shaina Sisle with Banrian Capital.

Great to see both of you again.

Welcome back to ETF Battles. >> Thank you so much for having me. >> It's great to be back, Ron. >> So, we got our four battle categories.

Cost, exposure, strategy, performance, and yield are combined.

And then we got our mystery category where you, our judges, can pick whatever criterion or factor that you feel is crucial to today's contest.

Our judges can also nominate wild card ETFs or they can opt for split decisions.

I've got scorekeeping duties.

At the end of the program, we will declare an overall winner.

Keep in mind that none of the battle outcomes on this program are ever predetermined or known in advance by myself or our judges.

So, let's kick things off with the first category.

It's sisters before misters.

Cost is the first category.

Shaina, please get us started.

So, I'm going to do something I don't normally do here, which is I might give the winner to the one that doesn't have the lowest expense ratio.

Let me explain.

So, if we do it solely on expense ratio and trading spread, it goes to Vanguard with three basis points, a spread of 1 cent, uh, and over 40 billion in assets under management.

Uh, Vanguard is clearly the cheapest.

However, I am going to give the win to Van X Fallen Angel ETF.

And the reason why is it's ETF um expense ratio is 25 basis points, similar spread uh 1 cent.

But the reason I'm giving it to Vanac is the Vanguard fund is a passively managed uh fund plain vanilla and um playing in a the investment grade short duration kind of space.

It should have a very low expense ratio.

I'm more impressed with VANC being able to have a 25 basis point expense ratio and the type of tradability that it has on a fund that's actively managed that's incorporating a fairly differentiated approach to how this fund is managed.

So while it is not necessarily the cheapest of the three, it is still extremely inexpensive for the management you're getting and the style of the fund.

So I don't normally do that but in this case I feel very strongly that it stands out for its ability to provide the type of strategy it is providing at the uh cost that it is uh um providing to the market.

So for me it's an >> great counterintuitive thinking and analysis.

You don't always get what you pay for sometimes you pay for what you get.

Thank you Shaina.

Tony you're up next.

How do you see it when it comes to cost? >> Shaya's right. uh Angel compared to FALN which is the other um the other fallen angels high yield bond fund is significantly cheaper than dual 25 bips for what it does in a fairly illquid section of the high yield market is competitive.

Uh I am more literal.

I see three basis points for VCSH and I hit buy because if you're looking for a substitute that delivers a yield pickup over say a short-term treasury fund um at a three basis point drag, this is among the cheapest options.

And it's worth noting that this used to cost four basis points.

Vanguard recently lowered the fee by one basis point on VCSH and a total of actually 168 share classes across 87 funds.

So this was part of their widespread fee cuts that just went into place.

So, some of you are looking at Vanguard funds and you haven't seen them in a while.

Well, like VCSH, they've gotten cheaper recently. >> So, your pick is >> VCSH. >> All right.

So, that takes us next to the exposure category.

Tony, you're still up.

So, break it down for us.

How do these three ETFs compare? >> Three totally different strategies.

The easiest one to understand is VCSH.

You're looking at investment grade corporate bonds.

So, tripleB and higher ratings with a weighted average maturity of 1 to 5 years.

In practice, this translates into uh pretty minimal interest rate risk.

You got a 2.7year duration.

So, this one is going to move more with the short end of the yield curve.

And of course, staying investment grade in your corporate bond exposure means you get a yield pickup over treasuries, but not so much as high yield short-term bonds.

So, right now, you know, this is kind of like your I want to keep my cash somewhat safe, but earn a little more than what I can get from say a money market fund.

Um, HYGH is the interesting one.

So this ETF actually holds HYG as one of its underlying which is iShar's like big liquid high yield bond that is particularly suitable for traders but it complements this with a allocation to interest rate swaps and what that does is that that mitigates a lot of the losses from rising rate years like 2022 but you lose the potential upside from years where interest rates fall.

So if you think about it from a total return perspective you're basically taking the interest rate interaction with bonds out of that.

So it's more to do with coupon clipping at this point.

And then AMGL is all about fall angels.

So these are previously investment grade bonds that have since been downgraded.

And the theory there is that you know on the you catch them on the rebound from a total return perspective.

There's a theoretically a better risk and return trade-off.

But again when you package it into ETF it all depends on execution.

So when I think about how these exposures are, you know, suitable as in like an overall best for investors, I would go with A&GL because it's it's it's a very wellexecuted um access to a segment of the market that is traditionally excluded from a lot of the bonds that investors especially on the retail side will hold, which is an aggregate strategy.

If you have an aggregate strategy like BND or AG, you are going to own the kind of stuff in VCSH.

Whereas for HYGH, I'm not really a fan of the use of swaps.

I don't like to hedge out certain types of risk.

I think you're compensated for that.

You know, it's more of a timing issue.

In 2022, it really didn't work well, which is why HYGH has done better than just HYG unhedged.

Whereas for A&G, you have a rare opportunity, like Shaina mentioned, to get what is traditionally a fairly inaccessible part of the high yield market and one that has better risk and return characteristics for in in a liquid, accessible, and cheap vehicle.

So on the exposure angle, I would go with A&GL. >> Got it.

Shaina, you're up next.

How do you see it when it comes to exposure strategy? >> So I'll start with the headline.

I agree with Tony.

A&GL is my winner in this category as well.

Um, you know, just to dive a little bit deeper into some of the things that Tony already mentioned. uh VCSH the Vanguard fund is passively managed focused on low uh one to fiveyear uh maturity corporate bonds.

Um so unlike a traditional short shortterm fixed income product that includes governments and corporates this is just in the corporate sector which allows it to have a little bit better yield.

Um I really dislike HYGH.

I think Tony was very diplomatic about what he said.

Um, my feedback on it is this is a fund that you would only be interested in if it was a rising rate environment.

And even then, when rates rise, you're usually compensated in some way through the yield and the coupons of high yield for that.

Um, so while there might be a short-term dislocation and some volatility, overall it kind of evens itself out over time.

I would not want to get into the game of trying to choose when I should own this fund.

In fact, when I was doing my research on the fund, one of the first articles that came up is how much money has has moved out of this product in the last 12 months because it is really just when rates are rising.

It's hedging interest rates, but the only time that's an advantage is if rates are going up, not when they're going down.

That's actually the environment you want the interest rate exposure.

Um, and so I don't like it.

Like Tony said, it uses swaps.

That brings in additional risks.

When you use options, you start worrying about optionality, volatility in option markets.

Swaps are a form of a derivative in a way, not technically an option like a call or a put, but in the same world.

Um, and then um the counterparty risk you're bringing in there as well.

And so I just think that you're bringing in risk for a a timing vehicle and I don't think it's necessary.

Um so for me the winner here is AMGL.

Um I I like the um idea behind the strategy.

So from a yield perspective it's going to have attractive yields.

The concept here is and it's it's pretty well documented over history that when a bond is issued if it's investment grade and over time it downgrades to below investment grade, it does tend to stay higher up in quality even after the downgrade versus other high yields.

So it doesn't tend to move downwards um as much or as quickly as something that's issued as uh below investment grade at the start.

The other thing is that the market knows when a when a company is on watch and is likely to be downgraded.

So most of the the selloff in the security happens before it actually gets downgraded.

So the opportunity is to buy it once it is because all of the all of the sell off has happened and then you usually get a bounce because the event happened and so now you have transparency and you have forward looking and you can move and consider other aspects of the security at that time like the overall well-being of the company and so on.

Historically, it has been shown that these types of bonds um outperform other high yield vehicles over pretty much every conceivable market environment.

There's a really great chart on the Van site that walks through this.

Um, and hopefully we'll have that up on the screen.

But, um, for me, the active management component, it's a very inexpensive fund, all things considered, as I already pointed out.

And it's extremely well executed from a standpoint of the strategy and the the actual academics behind it support that this is a strategy and an approach that should outperform over a full market cycle and also outperform other high yield funds over every conceivable market environment.

So, for me, Angel is the winner here.

Also, huge, huge shout out to Vanac for having the coolest tickers. >> Yeah, these are the vanity plate tickers.

Uh the ones that uh everybody wants.

So, uh Yes.

Yes.

So, that takes us next to uh performance and yield.

And uh we're going to combine these uh two factors together.

So, Shaina, you're still up. you already kind of alluded to to uh both of these uh items.

So, break it down for us.

How how do the these funds look when it comes to performance and yield? >> Keeping in mind that these three funds are playing in different markets and so the performance is going to be wildly different across them.

Um and because we're not comparing them to their peers, we're comparing them to each other.

Like I just want to caveat that because that doesn't mean that say VCSH isn't a great fund versus other short duration opportunities.

It's just it's being compared in this battle to high yield which should outperform and have better returns and yield over time.

That's the whole point.

You're taking on greater risk.

So you should get greater reward.

Um, for me, uh, the winner of performance and yield is AMGL.

Again, it outperforms over all common time periods except for the 5-year, which is to be expected because 5 years brings us back to an environment where rates were rising, and you would expect HY GH to have outperformed at that time, and it did.

Um but that is the only period at which it outperforms is that 5-year and it's largely because it got a lot of excess return during um a period when rates were rising.

Um from a yield perspective I looked at both yield to maturity and distribution yield and to me distribution yield is the most important number because that's what goes in your pocket.

All the others are just you know different calculations as required by the regulator.

But distribution yield is what you actually receive.

HYGH has the highest distribution yield at just over 7%.

Um, with AMGL uh just behind that at 6.12%.

Um, and then VCSH is at 4 and a quarter which is actually quite high considering its investment grade short duration.

Um, so all three have impressive yields and on their own compared to their peers stand out.

But when I combine both yield and performance, a A&G is the winner of this category. >> Thank you, Shaina.

Tony, you're up next.

How do you see it when it comes to performance and yield? >> Uh, no contest here.

Uh, AMGL just absolutely destroys on a total return basis.

So, over the 14 point, sorry, over the 11.4 four years from 2014 May to uh present day we're looking at a uh a annualized return of 5.98 for A&GL whereas HYGH trails at 4.58 and VCSH of course given the much lower credit risk you're taking here uh 2.57.

Um one interesting note about the yield is that HYGH's 30-day SEC yield is significantly lower than the unhedged HY despite only being slightly more expensive in terms of its net expense ratio.

That is going to be the drag from the swaps there, right?

That there is a hidden drag from the use of these.

You see it in leverage ETFs and we're seeing it here is that you are going to lose some of that yield and over time that does play a difference in your total return potential.

Um again, I concur with Shaina here.

A&GL is the winner. just, you know, not only are you clipping those above average coupons from non-investment grade issuers, but as Shaya mentioned, there's a substantial price return component to this ETF to favorable credit environments where these so-called fallen angels will see better upside potential compared to your average high yield bond.

All right.

Well, that takes us next to our mystery battle category.

This is where our judges can give us that mystery factor or thing.

And it's a surprise.

That's why it's the mystery category.

We don't know what it is.

So, surprise us, Tony.

What's your mystery battle category factor and which of these ETFs wins it? >> I'm going to throw in a um a wild card here.

Uh my own and it would be SRLN which is the State Street Blackstone senior loan ETF.

Uh when I do invest in bonds, and I don't do this very often, I like to have two things.

One is I want to be in a first lean position, right?

If I am lending someone money, if something goes wrong, I want to be the first person to be paid back in that stack.

And the second thing is that I I'd like to be invested primarily in floating rate loans.

Of course, in a falling rate environment, this is going to be less than optimal, but over a full credit cycle, that's the kind of positioning I want to be.

So, if you combine these two, there's only really a few assets that fall into there.

And I'm not going to touch cos because, you know, with all the contagion in the uh private credit markets, I don't want to be in there.

But, I don't mind being in first lean senior secured floating rate bank loans.

And you got a lot of ETFs out there for this really.

You could throw a dart and pick a couple decent ones.

I like SRLN.

It's not really cheap at 70 pips, but it's well capitalized at uh over 6.5 billion in AUM.

Right now, you're getting a weighted average all-in rate of 7.5%.

And then uh approximately 47% of the loans have a software floor.

The yield isn't bad. on a 30-day SEC basis, you're looking at 7.56.

But unlike sorry, like all the options we talked so far, this is corporate paper, so the after tax efficiency isn't that good.

So, one thing that mystery battle category that I would like all viewers to take to heart is that you're going to want to keep these in a tax sheltered account because the tax drag is much worse than what you would get from a treasury only fund, which is um exempt from state tax, most of them, or from a municipal fund, which is exempt from federal.

So, corporate paper, not tax too well, ordinary income, keep it in your Roth or something.

So, for this category, I would be pitching SRL in. >> All right.

And that's the Will Rogers approved wildcard choice.

He said that it's not uh the return on my capital, it's the return of my capital.

Give me back my money.

Thank you very much, Tony.

Shaina, you're up next.

Uh, what is your mystery battle category and which of these ETFs catches your fancy?

For my mystery battle category, I was very much going to determine what my category was going to be based on where Tony went with his.

Um, and so I am going to focus on HYGH and the swap aspect of it.

It's really hard to have a mystery battle category here where we can address all three products cuz they're all really, really different.

But I want to take a moment to talk about hy gh because I think some of the things that Tony brought up are really important and people should just understand the concept of hedging any aspect of a return strategy.

So this stuff is applicable here where we're trying to hedge out the interest rate component of fixed income.

And then another place where this is also commonly done where you're hedging some risk is in um international or non- US equity funds where they're hedging out the currency.

And so in both cases they use derivatives to do this which can introduce a number of different risk factors that you need to be considerate of.

Um I want to kind of pick on HYGH not because I I don't think that you know the issuer doesn't put out great product. they do.

Um I just don't think that doing an interest rate hedge, especially in high yield, is merited.

Um I don't know that it's smart.

You really have to be specific on when you own it and really have a good view of what the interest rate environment is going to be over the long term or else it's just a trading vehicle.

And quite frankly, if you're that concerned about interest rate hedging to the point where like you're looking for these products, you might want to consider just doing your own overlay so you can have better control over it and have better control of the risks and the cost associated with it.

So in this particular case, as Tony pointed out, the yield gets chipped away at because in order to have the overlay to hedge out the interest rate risk, you have to buy swaps, which means you use yield that's being created from the product to do so.

And that is always going to chip away at not just the yield, but also excess returns of the product.

So you have to ask yourself, is the entire exercise even worth it if basically the cost of doing it is what you lose in your return anyways?

So for me, um I just want to flag for the audience that anytime you're dealing with something that has hedged in the name, you want to understand how they pay for the hedge and how that will impact your overall returns.

You also want to consider the following things.

Anytime you're doing something that's hedged, you want to consider who the counterparty is, what the risk may be, the liquidity of the market that they're you um that um the hedge is coming from um in a number of different ways because hedge can mean a lot of things, but whenever you're using derivatives or any sort of optionality, um how that that insurance, if you will, gets paid for matters and then who the counterparty on that insurance is also matters.

Those are two additional risks you just bring into the scenario that may or may not be worth it.

It can be in some cases.

In this case, I would argue that the cost of the insurance is substantial enough that any benefit you would get from the insurance takes away from overall return opportunities elsewhere.

And so at the end of the day, you end up long-term having less attractive returns than if you didn't hedge at all.

Um, so for me, I'm just going to flag that I don't have a wild card here, but I love that Tony mentioned floating rate.

Well, I didn't go and try to find a floating rate fund.

My initial inclination of this battle is that if I was going to do fixed income and I was going to get away from the traditional like, you know, um, what is it?

BIL and like the longer term ones like that are the the basis.

Um I would want to do something that's going to be additive to the portfolio and diversifying and floating rate has a lot of advantageous um um attributes um to it that can be really attractive especially in rate environments where you're seeing changes in rates that are happening in in a fluid way.

Um they also have other benefits.

Um depending on the floating rate structure, you can have you can be higher up in the cap structure of the fund um um than say a high yield or the corporate issuance because they typically have um some sort of um what's it called?

Um uh um starts with a ten seniority. >> Um yeah, but there there oh pick there's often pick clauses in these um um which is your preferred uh aspect in the the cap structure.

Um and and the managers who tend to run floating rate funds are extremely into the weeds and all the different aspects of the security um more so than a lot of others.

So I love all the floating rate funds.

Most of the funds that I'm attracted to in fixed income are non-traditional or multis sector and a lot of them don't come in ETF form so I didn't have a wild card.

But I do really love Tony's idea of like a senior security or a floating rate type of option in the space um as a compliment for a traditional fixed income.

So I'm going to kind of jump on the bandwagon and um support Tony's wild card for this category. >> Look at that.

Judges agreeing on the wild card choice.

I like it.

So now we move to the part of the program where our judges can give us their overall battle winner.

So Shaina, give it to us.

My winner is AMGL.

Um I think in a category where I approached it as thinking of somebody who's looking for an outside the box fixed income complement to like traditional um fixed income and these were kind of the options they were considering.

I think has the best risk um adjusted return opportunity.

Um it's extremely well executed.

It has a strategy that has a long historic research that supports that this is a repeatable outperformance type of vehicle.

Um it is not particularly sensitive to certain types of um market environments.

Um it is an excellent complement to you know a conservative fixed income portfolio where maybe your client or yourself doesn't want to take on the risk of true high yield.

This is kind of a quality bias high yield where you can get a lot of the advantages to having high yield in your portfolio but done in a way where the research and the history backs up outperformance and quality is uh consistent over time for the approach.

So for me it's the winner of uh this battle.

Um and it's not even close. >> Tony, your final chance to weigh in with your overall winner. >> I'm going to go with A&G too. 25 pips for uh high yield exposure on its own is pretty good.

Doubly so when it's a more advantageous segment of the market.

Uh I really don't like HYGH.

I was looking at HYG and it has an effective duration of 2.87 years.

So you the the interest rate risk for HYG is already minimal.

It's it's like barely worth noting in my opinion.

And now we're paying extra on top of it to hedge it out with swap.

So you take out interest rate risk, reintroduce counterparty risk, lower the liquidity, and reduce your yield, right?

It's just one of those things where you're taking uh two steps back and one step ahead essentially.

So I really don't like that VCSH is, you know, just just your average Vanguard product.

It's low cost.

It does its job.

It serves a purpose and for the majority investors is good enough.

But if you're looking for something to actually differentiate your fixed income exposure, uh very few out there like AMGL and Eyesshares actually has their own uh Fallen Angels ETF called Fallen and it's just inferior when it comes to cost.

I think it loses on performance too.

Um so I agree with Shane.

I'm going to go with A&GL for as my winner.

Well, our judges have spoken and according to our final battle scorecard, today's winner is going to be Angel.

Our judges agreed in most categories uh on this particular ETF and they made some excellent arguments and analysis.

Obviously, Angel has a a pretty long-term track record, compelling historical outperformance.

We don't know, of course, if that'll uh continue in the future, but what we do have is an ETF that has delivered and uh it's it's been impressive, quite frankly, and our judges like that.

Also, it's something very different that when you probably already own inside your bond portfolio.

If you're the typical ETF investor, you probably already have something like BND or a AG, you know, exposure to the total bond US bond market.

But this uh angel may give you uh some complimentary exposure um to to that uh that core holding.

So, that was a point that our judges made and a lot of great other points, counterparty risk.

You know, the other thing I think the key takeaway that I've learned is our judges really disliked HYGH a lot.

Yes. >> So, uh, and they explained explained it pretty clearly and I thought the analysis was spoton.

An absolute clinic when it comes to, uh, analysis on on these ETFs and great job to both of you.

Thank you so much, Shaya and Tony.

Well done.

I say this all the time, but a lot of times um ETFs come out that are packaged really well marketing wise.

And um they kind of expect that the um the market they're targeting doesn't understand some of these concepts.

So shows like this are here for you to help you understand something that's really well packaged from a huge issuer.

Um to understand that sometimes they're just for lack of a better word, the product makes no sense.

In this case, I I cannot make heads or tails of why anybody would even care about this. >> They got good with the timing.

A lot of the inflows came during 2022.

So again, there's a lot of investors fleeing into a strategy that looks like it's doing well without understanding that long-term, aside from a very particular type of interest rate environment.

You're going to see a structural drag year after year. >> Amen.

Well, thanks again to Tony and Shaina and uh to you, our audience, for the excellent ETF battle requests.

Keep them coming.

Hit us up in the description section below with your ETF tickers.

I'm Ronda Ley with ETF Battles.

Thanks for watching.

We'll see you on the next show.