{"id":91429,"date":"2024-07-08T01:05:44","date_gmt":"2024-07-08T05:05:44","guid":{"rendered":"https:\/\/ifintechworld.com\/?p=91429"},"modified":"2024-07-08T01:05:47","modified_gmt":"2024-07-08T05:05:47","slug":"scyb-etf-strategic-exposure-to-a-risky-sector","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=91429","title":{"rendered":"SCYB ETF: Strategic Exposure To A Risky Sector"},"content":{"rendered":"
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Schwab High Yield Bond ETF (NYSEARCA:SCYB<\/span>) has been an ETF I’ve had my eye on for a while. SCYB has been around for a little under a year and has an AUM of about $187M. SCYB tracks the ICE BofA US Cash Pay High Yield Constrained Index. This index has some special criteria that make SCYB’s holdings attractive. I have not been a fan of high-yield bonds in the past year; in fact, I have 2 high-yield ETFs with Strong Sells. However, since June of last year, I’ve been bullish on <\/span>HYBB, an ETF that holds only BB bonds. If you care to read my articles on HYBB, you can find them <\/span>here and <\/span>here. As the data continues to come in at the Goldilocks range, I’m willing to start incorporating some slightly lower-rated high-yield bonds into my portfolio, and SCYB is my ETF to do that.<\/span><\/span><\/p>\n

Holdings<\/h2>\n

SCYB holds 1,562 high-yield bonds. The index ensures that no one issuer is responsible for more than 2% of the index’s holdings, which makes SCYB a well-diversified ETF. SCYB has an effective duration of 3.3 years, which is on the lower end. While SCYB is by no means a low-risk ETF, its lower duration does limit some interest rate volatility. Its average maturity is 4.4 years, with over 40% of its holdings falling into the 3-5 year range.<\/p>\n

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SCYB’s holdings by maturity (Schwab.com)<\/span><\/p>\n<\/figcaption><\/figure>\n<\/p>\n

Due to index criteria, SCYB only holds bonds rated B or better. Approximately 53% of the ETF is in BB-rated bonds, and 45% in B-rated bonds.<\/p>\n

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\"SCYB's<\/span>
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SCYB’s holdings by credit rating (Schwab.com)<\/span><\/p>\n<\/figcaption><\/figure>\n<\/p>\n

This makeup of higher-rated high-yield bonds is what makes SCYB attractive.<\/p>\n

BB and B bonds are risky, but based on the current economic environment, I don’t see any reason to expect a rise in default rates. Many other high-yield ETFs own large amounts of CCC and below-rated bonds. These are the junk bonds I’m really worried about. Not only have CCC bonds had far higher default rates than B and BB bonds, but there are also current technical factors that make me even more bearish about CCC bonds.<\/p>\n

Defaults<\/h2>\n

It’s not a surprise that CCC bonds have more defaults than B bonds, but it might be surprising to some how big of a difference one notch can make. From 1994 to 2015, B-rated bonds averaged a default rate of 2.8%. During that same time period, CCC bond default rates were over 11%, almost 4 times higher than that of B’s! The following chart is from one of my past articles, where I argued BB bonds were “in a league of their own”. While I still believe that lower-risk investors can use BB bonds to add yield for only a little more risk compared to BBB bonds, for more risk-tolerant investors, B-rated bonds look good too.<\/p>\n

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Default rates of bonds by credit rating (www.incomeresearch.com)<\/span><\/p>\n<\/figcaption><\/figure>\n<\/p>\n

The only thing that looks awful is CCC bonds. And I think things are getting even worse for them.<\/p>\n

CCC bonds<\/h2>\n

CCC issuance has been down dramatically. In 2023 CCC rated bonds accounted for less than 1% of high-yield issuance. Before 2023, the previous low was 3.7% in 2009. The low issuance is due to a variety of reasons. First, CCC companies would have to issue new debt at rates far higher than they are used to. With the risk-free SOFR rate at 5.33%, these companies have to add quite a bit of yield to entice investors. CCC-rated companies are trying to wait out the high rates so they can issue after rate cuts in order to have lower interest expenses. Another reason is that CCC-rated companies are turning to private credit to get lower rates. The last reason is that interest expense is too high for companies to issue debt to participate in M&As. While this issue affects all of the bond market, it hits the already struggling CCC bond market harder.<\/p>\n

All these factors that cause lower supply also artificially raise prices and cause spreads to be tight. Spreads across the entire fixed-income sector are tight, but because of the technical factors I discussed, CCCs valuation is hit even harder.<\/p>\n

B and BB bonds<\/h2>\n

Now that I’ve discussed why CCC bonds shouldn’t be in your portfolio, let’s address why I’m willing to add some risky B and BB bonds. SCYB’s 30-day SEC yield is 7.7%. The chart below shows SCYB’s yield compared to HYBB and BND.<\/p>\n

<\/span><\/p>\n\n\n\n\n\n
ETF<\/td>\n30-Day SEC Yield<\/td>\nSCYB Yield Spread to ETF<\/td>\n<\/tr>\n
SCYB<\/td>\n7.7%<\/td>\n—<\/td>\n<\/tr>\n
BND<\/td>\n4.69%<\/td>\n+301 bps<\/td>\n<\/tr>\n
HYBB<\/td>\n6.47%<\/td>\n+123 bps<\/td>\n<\/tr>\n<\/table>\n

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