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Best High-Yield Bond Funds For 2015 – Part 3

Summary HYD has a higher yield and lower credit quality. HYMB has higher credit quality and better total return history. HYMB has large exposure to California. In part one , we compared the two largest high-yield bond funds: iShares iBoxx $ High Yield Corporate Bond (NYSEARCA: HYG ) and SPDR Barclays Capital High Yield Bond (NYSEARCA: JNK ). In part two , we compared two short-term high-yield bond funds: PIMCO 0-5 Year High Yield Corporate Bond (NYSEARCA: HYS ) and SPDR Barclays Short Term High Yield Bond (NYSEARCA: SJNK ). In part three, we will look at the offerings in the high-yield municipal bond space: SPDR Nuveen S&P High Yield Municipal Bond (NYSEARCA: HYMB ), Market Vectors High-Yield Municipal Index (NYSEARCA: HYD ) and the much newer Market Vectors Short High-Yield Municipal Index (NYSEARCA: SHYD ). Index & Strategy HYD tracks the Barclays Municipal Custom High Yield Composite Index while HYMB tracks the S&P Municipal Yield Index. HYD was created in February 2009, HYMB in April 2011. These two funds have a correlation of 0.9836. On the expense ratio, HYMB has an asterisk because it is currently subsidized through October 31, 2015. Without the subsidy, the expense ratio would be 0.50 percent (the yield would also dip 0.05 percent). On volume, HYD’s price is half that of HYMB, so dollar volume is about three times higher for HYD. HYD has a higher yield, lower expenses and longer average duration. As we’ve seen when comparing other high-yield ETFs, total returns have favored the funds with shorter durations, lower yields and higher credit quality. As for the latter, HYD has 30 percent of assets in BBB rated debt; 22 percent in BB; and 17 percent in B. HYMB has superior credit quality, with 21 percent of assets in A rated debt; 22 percent in Baa; and 33 percent below Baa. Both portfolios have about one-quarter of assets in unrated debt. Both funds give a geographic breakdown of their assets as well. HYMB has 14.2 percent of assets in California, while HYD has only 8.9 percent in the state. HYMB’s next largest state is Texas, with 7.5 percent of assets, while HYD’s second largest holding is NY with 8.5 percent of assets. One other option out there is Market Vectors Short High-Yield Municipal Index. The fund tracks the Barclays Municipal High Yield Short Duration Index. It has an expense ratio of 0.35 percent and a yield of 3.10 percent. It has a duration of 4.17 years. The fund is overweight Texas, at 10.5 percent of assets. Credit quality is 48 percent in BBB rated debt; 16 percent in BB; 10 percent in B; and 2 percent in CCC. It has higher credit quality than HYD. The fund has only $80 million in assets and trades about 20,000 shares per day. SHYD had only one year of history, with an inception date in January 2014. Performance The price ratio chart of HYD and HYMB shows HYD in a persistent downtrend, signifying under performance. However, there are two clear periods when HYD outperformed: summer 2011 and summer 2013, while under performing in July 2014. (click to enlarge) Summer 2011 was a period when investors worried about sovereign debt in the U.S. and Europe, getting to the point where people were discussing a U.S. Treasury default. In summer 2013, Detroit declared bankruptcy , while in summer 2014, Puerto Rican bonds sold off sharply. This shows that the portfolios have deviated substantially when volatility increases. A performance chart shows that only the Detroit bankruptcy led to significant price declines. (click to enlarge) Income HYMB has a 30-day SEC yield of 3.83 percent versus HYD’s 4.31 percent yield. As has been the case with other high-yield funds, falling interest rates have weighed on the fund’s payouts. (click to enlarge) Risk & Reward Compared to the Barclays Municipal Index, HYD has a beta of 1.50 and HYMB has a beta of 1.61. Investors are taking on more market risk with these funds as compared to aggregate muni bond funds and the beta reflects this. The Barclays Municipal Index has a standard deviation of 3.72. HYD has a standard deviation of 6.24 and HYMB a standard deviation of 6.42. These standard deviations are higher than any of the junk bonds previously covered in parts one and two. This is due to the volatility surrounding Detroit’s bankruptcy in 2013. High-yield corporate bonds have enjoyed a smoother ride over the past three years and this is reflected in their lower standard deviation. Bloomberg’s ranking of states by their underfunded pensions shows a wide gap between the states when it comes to financial management. Between HYD and HYMB, the one state that sticks out is California. While most state exposure is similar, California accounts for 5 percentage points more of HYMB’s assets. Investors with a strong opinion on California’s long-term finances can opt for one fund over the other, but for other states, single state exposure is not as large a concern. Conclusion Municipal debt is not out of the woods because unfunded liabilities will eventually become a public debt if the municipality doesn’t go bust first. In the long-run, that favors HYMB’s superior credit quality-assuming California isn’t one of the problem states in the future. As for 2015, municipal bonds appear to be in good shape. Investor interest in municipal bonds recovered in 2014 after a drop in 2013. The Federal Reserve Z1 report shows municipal debt was $2.999 trillion in 2009, and as of Q3 2014, that number fell to $2.908 trillion. State and local governments have been slowly repaying their debt, leaving many states in a stronger financial position than they were six years ago. Liabilities such as unfunded pensions are a concern in states that haven’t addressed the problem, but overall the supply of muni debt has stayed constant as the economy has grown. While the municipal bond market looks attractive next to corporate junk bonds in terms of risk/reward, PIMCO 0-5 Year High Yield Corporate Bond (covered in part two) appears more attractive for 2015 given it has declined since the summer along with high-yield corporate bonds. If the economy stays strong in 2015, HYS is likely to recover and deliver some capital appreciation. It lacks energy exposure, which could struggle if the U.S. dollar continues its rally in 2015, and that could help it beat other high-yield bonds funds this year.

Materials ETFs Mauled By Falling Oil Prices

Summary Energy prices are falling. Low oil prices are weighing on the materials sector. Materials are experiencing lower activity on energy fallout. Oil’s slide has identified some winners at the sector level, namely consumer-related shares, but beyond the energy sector, there are some losers as well. Those losers include the materials sector, which was already scuffling heading into 2015. Last year, the Materials Select Sector SPDR ETF (NYSEARCA: XLB ) rose just 7.2%, including paid dividends. XLB’s 2014 showing was 630 basis points worse than the S&P 500, and enough to make the fund the second-worst of the nine sector SPDR ETFs, behind only the Energy Select Sector SPDR ETF (NYSEARCA: XLE ) . To this point in the new year, only three of the nine sector SPDRs have traded higher. XLB is not a member of that trio. In theory, materials stocks should be winner in a low energy price environment, because lower oil and gas prices reduce input costs for energy-intensive materials producers and chemicals manufacturers. In reality, that has not been the case. While the materials sector’s earnings warnings have not yet reached alarming heights, it is clear oil’s plunge is taking a toll on the sector. Of XLB’s top 10 holdings, a group that combines to make up about two-thirds of the ETF’s weight, only three have traded higher to start 2015. “The investment markets reflect these winners and losers in the economy. Consumer driven sectors of the market have performed quite well. The energy and commodity sectors of the market have not. Between oil stocks, the materials sector, and industrial and utility names in commodity-related businesses, roughly 20 percent of the S&P 500 is a loser with falling oil prices.” – Jones & Associates LyondellBasell Industries (NYSE: LYB ), one of XLB’s top 10 holdings, said that in the fourth quarter low oil prices will damp its margins. That after the company helped materials ETFs perform well in the first half of 2014 on the back of rising crude prices . A recent Morgan Stanley report highlighted PPG Industries (NYSE: PPG ), a top 10 holding in XLB, as one materials name that could endure lower oil prices, but the bank also identified Eastman Chemical (NYSE: EMN ), LyondellBasell and Dow Chemical as potentially challenged by lower oil prices. Those stocks combine to make up over 16% of XLB’s weight. XLB’s five-year correlation to The United States Oil ETF (NYSEARCA: USO ) is over 59%, according to State Street data . Materials Select Sector SPDR ETF (click to enlarge)

Tech ETFs With Global Footprints At Risk

The U.S. dollar continues to appreciate against other overseas currencies. Large-cap companies with heavy overseas exposure could see revenue slow due to currency risks. Tech sector at risk of overseas exposure. As foreign central banks enact loose monetary policies, a strong U.S. dollar will negatively affect prominent technology stocks, along with related-sector exchange traded funds, that have significant overseas exposure. The Technology Select Sector SPDR ETF (NYSEARCA: XLK ) has been outperforming the broader markets, but a strong dollar could crimp the sector’s performance. XLK has declined 1.5% year-to-date and increased 16.0% over the past year. Meanwhile, the S&P 500 has dipped 1.7% year-to-date and risen 12.3% over the past year. A “strong dollar is negative for any company with significant overseas business,” James Kelleher, director of research at Argus, said in a CNBC article. “Companies like IBM and HP can’t totally avoid a currency headwind at the cost of being a global company.” According to Kensho quantitative analytic data, when the U.S. dollar appreciated 5% or more over 60 trading days on 10 separate occasions since January 1, 2005, tech companies were among the worst performers over the following three months. For instance, Hewlett-Packard (NYSE: HPQ ) traded in the red 70% of the time, with a negative median return of 4.51%. Intel (NASDAQ: INTC ) traded negative 70% of the time, with a median return of 2.97%. Adobe (NASDAQ: ADBE ) was negative 60% of the time, with a median negative return of 5.19%. IBM Corp. (NYSE: IBM ) also blamed the strong currency Tuesday for erasing any chance of a revenue increase this year, following its earnings report. XLK includes a 3.8% tilt toward INTC, 3.7% in IBM, 1.5% in HPQ and 0.9% in ADBE. Semiconductor ETFs, like the Market Vectors Semiconductor ETF (NYSEARCA: SMH ) and iShares PHLX SOX Semiconductor Sector Index ETF (NASDAQ: SOXX ) , also have significant exposure to INTC, which makes up 19.8% of SMH and 8.0% of SOXX. Additionally, the increasingly popular tech dividend ETF, First Trust NASDAQ Technology Dividend Index ETF (NASDAQ: TDIV ) , holds large positions in these large and stable tech names, including INTC 8.0%, IBM 8.0% and HPQ 3.0%. FX headwinds were “really the difference between growing pretax income and not growing pretax income in the fourth quarter for us,” CFO Martin J. Schroeter said. “Now, in this currency environment, and with the divestitures we’ve completed, our total revenue as reported will not grow in 2015.” An appreciating U.S. dollar makes U.S. products relatively more expensive in overseas markets. Sales in foreign currencies will translate to a lower U.S. dollar-denominated return in a strong U.S. dollar, or weak overseas currency, environment. Fueling the continued strength in the U.S. dollar, major central banks have been implementing loose monetary policies and enacting quantitative easing. For instance, all eyes were on the eurozone as the European Central Bank contemplated a Federal Reserve-styled bond purchasing program. “Policy diversion is driving this rally,” Win Thin, global head of emerging markets at Brown Brothers Harriman, said in the CNBC article. “The divergence is U.S. raising rates and the ECB, BOJ expected to do more easing, which typically weighs on a currency. Everyone’s very bullish on the dollar. The fundamental backdrop still favors the dollar.”