iShares SHYG ETF Is Not The Best Middle-Ground

The iShares 0-5 Year High Yield Corporate Bond ETF (NYSEARCA:SHYG) is a way to target higher yield fixed income exposures for your stock account. The idea here is that credit ratings are higher, but this ETF incidentally also has lower average duration, and is therefore less exposed to interest rate changes. While lower duration is not necessarily to fault, we do lean towards the opinion that peak rates are close. Moreover, we think the maturities are still long enough to miss some nice reinvestment windows which may close if the rate narrative changes the position of the yield curve. Finally, we don’t think there’s value in betting for a better-than-consensus view on corporate credit quality.

Key SHYG Facts

Let’s start with the key facts around SHYG. The effective duration, i.e., the weighted average of the duration of the underlying instruments, is 2.53 years. The YTM is high at 8.65%, which represents more than a 4% premium over risk free rates with the same maturity. This is consistent with the BB and B rated profile of the bonds, more or less – it may be on the low side.

The duration is 2.5 years but the average maturity is 3 years, with the sharper difference owed to the higher coupons on these bonds. The mode is maturities between 3-5 years, with very little maturing within the next two years.

Analysis

First of all, expense ratios aren’t that low relative to some other bond ETFs you find, but considering the commissions that come with buying bonds directly from broker-dealers, the 0.3% expense ratio is more than fine and constitutes good savings for the stock account owner.

The positives start to end there. The yield curve shape is such that shorter maturities are yielding very highly, but out from 1 year in maturity, the yields fall back to earth, around 4% until it tapers lower. The maturities of the SHYG will miss this nice window.

Moreover, our house view is that inflation will definitively peak in 2023 as we lap 2022, and the economies outside the US see pressure and take their foot off the buying pedal, namely Europe and China, together representing easily 30% of the world wallet. Rates will likely reverse faster than the markets expect, given consistent hawkish Fed messaging. Even the longer duration rates around 3.5% may not hold if the yield curve shifts back down.

Finally, we don’t think there is a strong value case to be made with the YTM of this portfolio given the credit qualities. While a decent 2.5-year duration will lever this ETF slightly to a peak rate speculation, the credit risk premiums themselves are low considering the credit risks. There may be better deals at this credit risk, and in general, betting on longer duration may be a more solid, albeit speculative source of value for shareholders.

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