Loan funds and short high-yield bonds held up when yields jumped

Senior loans rose in the third quarter, when the broad high-yield bond funds fell. A fund of high-yield bonds due within five years lost less than those funds.

Invesco Senior Loan ETF BKLN gained 2.0%, including income, from June 30 to Sept. 30. It holds senior loans, also called leveraged loans, and the interest they pay resets as market rates move.

iShares 0-5 Year High Yield Corporate Bond ETF SHYG lost 1.1% in that quarter. It holds high-yield bonds due within five years.

The median of the 85 exchange-traded funds in U.S. high yield returned 2.7%, including income, over the 12 months through Thursday, Nov. 5. It lost 1.8% in the quarter.

The three largest of those 85 funds, by assets, track broad high-yield indexes. iShares Broad USD High Yield Corporate Bond ETF USHY lost 1.8% in the quarter and gained 2.5% over the 12 months through Nov. 5. iShares iBoxx $ High Yield Corporate Bond ETF HYG lost 2.0% in the quarter and gained 2.2% over the 12 months through Nov. 5. State Street SPDR Portfolio High Yield Bond ETF SPHY lost 1.9% in the quarter and gained 2.5% over the 12 months through Nov. 5.

Over the 12 months through Nov. 5, BKLN gained 4.0% and SHYG gained 3.1%. Both finished ahead of those three funds.

The 10-year Treasury yield rose from 4.44% on June 30 to 5.29% on Sept. 30, a climb of 85 basis points.

On Sept. 16 the U.S. Federal Reserve raised the target range for the federal funds rate by 25 basis points, to 3.75% to 4%, and said inflation remains elevated.

"Higher Treasury yields and renewed Middle East tensions weighed on high yield bonds during the third quarter, while leveraged loans outperformed as their floating-rate structure provided protection from rising rates," Polen Capital wrote in its third-quarter commentary.

Those leveraged loans are the senior loans BKLN holds. Polen said the floating rate protected them from the rise in yields.

In the same commentary, Polen reported that the option-adjusted spread on the ICE BofA U.S. High Yield Index widened 36 basis points, from 276 to 312 basis points. The spread is the extra yield these bonds pay over Treasuries, after an adjustment for the chance a bond is repaid early. A wider spread means a lower price for the holder, even if the Treasury yield does not move.

BondBloxx CCC Rated USD High Yield Corporate Bond ETF XCCC holds CCC-rated high-yield bonds. It lost 4.4% in the quarter. Over the 12 months through Nov. 5 it lost 5.2%, while the broad funds gained.

iShares Core U.S. Aggregate Bond ETF AGG tracks the Bloomberg US Aggregate Bond Index, the broad investment-grade bond market. It lost 3.5% in the quarter, more than the median high-yield fund, and gained 0.7% over the 12 months through Nov. 5.

As of Sept. 30, iShares reported an effective duration of 5.71 years for AGG in its fact sheet and 3.26 years for USHY in its fact sheet. Duration is how far the price moves when yields change. The investment-grade fund had more of that exposure. In the quarter, a high-yield holder lost less than a holder of AGG.

State Street SPDR S&P 500 ETF SPY gained 2.4% in the quarter, when the high-yield funds fell, and 9.3% over the 12 months through Nov. 5, against 2.7% for the median high-yield fund.

What a holder is choosing is how much of a bet on Treasury yields the fund carries along with the income. The quarter showed the cost of that choice, and the 12-month results still show it.