BKHY: A Challenger To JNK In The High Yield Space (NYSEARCA:JNK)

Passive ETFs are everywhere. Buy the index and hit the snooze has been the mantra for the last decade and every attempt at predicting a change in the trend has been incorrect. But there are actively managed ETFs around and some have managed to corner a small amount of assets. We look at one today trying to make a name in the “high-yield” space and run it against SPDR® Bloomberg High Yield Bond ETF (NYSEARCA:JNK), the kahuna in the space.

BNY Mellon High Yield Beta ETF (NYSEARCA:BKHY) comes with some interesting perks for those who want to try and outperform in the high-yield markets. The fund was launched in April 2020 and thus dodged the pulse-pounding action of COVID-19. But it has managed to gather quarter billion of assets, so that is some achievement in this space.

It also has kept fees remarkably low for an actively managed fund. 22 basis points is really low and we think that was a product of the fund trying to make itself competitive during ZIRP (zero interest rate policy). That fee structure still holds today, so investors are getting a low-expense setup to start with.

The fund aims to match the high-yield index (yes not beat) using their proprietary credit model. The aim is to mitigate downside risks.

The fund seeks to match the performance of the Bloomberg U.S. Corporate High Yield Total Return Index.

Employs a systematic process designed to capture broad exposure with low tracking error vs. the benchmark, in a cost-efficient manner.

Proprietary credit model which seeks to systematically limit exposure to low-quality and overpriced bonds. We believe this can help mitigate downside risks associated with more volatile parts of the high yield market.

Is highly liquid so investors can buy or sell any time the market is open.

Source: BNY Mellon High Yield Beta ETF

For some, this might not make sense, as why would a fund just aim to match the returns of the index. Well, even matching is very hard as there are transaction costs that indices ignore. There are also liquidity issues as the indices assume that everyone can invest flawlessly in every issue. There are sampling errors as smaller funds cannot invest in every single issue that exists inside an index. Finally, there are fees, that subtract from a fund’s return. Indices lack them.

The Setup

The fund tracks its benchmark pretty closely in terms of asset allocation. In terms of industries, consumer cyclical and non-cyclical are the front runners in this fund.

JNK, which is one of the most popular ETFs for investing in junk bonds, tracks similarly. Note that JNK also provides the index breakdown below.

Based on the above, you can see that the fund has some changes in its allocation, likely stemming from its proprietary credit model. One thing that really stood out was that BKHY holds 1,726 different bonds. JNK, which is a fund with $8.5 billion in assets (more than 30X what BKHY has), holds these many.

This is mind-boggling that such a small fund is expanding its reach across so many more bonds. This has to create some slippage from liquidity issues. One point to note here is that JNK follows the “Bloomberg High Yield Very Liquid Index”. So it avoids some illiquid issues. But even when funds follow the index that BKHY does, they have room for sampling and substantially reducing a number of bonds held. BKHY seems to not go down this road.

The fund’s maturities are about in line with where JNK stands as well with a weighted average duration of 3.32 years (JNK is 3.22 years).

As expected, most bonds are in the BB and B categories with almost 11% in CCC category. JNK holds a little less in the last rung, but the difference is immaterial.

Performance

BKHY has matched the high-yield index, adjusted for the 22 basis points of drag.

That is not a bad accomplishment, all things considered. The size of the fund should have worked against it in turbulent times, but it really has not. Interestingly enough, it has beaten JNK handily over the last 3 years. Note that as stated before JNK follows a different index and that index has also underperformed the index that BKHY follows.

Since inception we can see a similar spread with BKHY coming out ahead.

Outlook & Verdict

What we have all been celebrating in the last few weeks is the expectation of rate cuts. Historically, this celebration has tended to be a rather poor choice.

Of course, if you were in Europe, you would be getting paid to take this risk in junk bonds. In the US you are not.

So we are not too keen on pursuing high-yield bonds as a whole, except on a case-by-case basis. That said, BKHY has done fantastically well for investors in relation to the asset class it is tied to. Underperforming the index by less than the fee expense takes a lot of finesse when you are buying 1726 different bonds. We think this is an interesting alternative to JNK, especially considering that JNK charges 18 basis points higher and is almost double the expense ratio. A key risk remains how the fund deals with rapid withdrawals during a prolonged bear market. The small size and possibly large number of illiquid issues will make things challenging.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.