When advisors and investors hear the terms “high yield” or “junk” as it relates to bonds, they understandably have some apprehension. After all, junk bonds carry elevated credit risk relative to their investment-grade peers. Hence the higher yields, which act as added compensation for the extra risk.
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Even some municipal bonds sport the high yield designation. That may surprise some fixed income investors, who view this corner as one of the safest next to Treasuries. Investors need not approach junk-rated munis with fear, however. Plus, thanks to the VanEck High Yield Muni ETF (HYD ), they don’t need to engage in the burdensome task of selecting individual issues.
The $4.04 billion HYD turned 17 years old in February. It tracks the ICE Broad High Yield Crossover Municipal Index. HYD, which yields 4.48% on a 30-day SEC basis, holds nearly 1,800 high yield municipal bonds. Indeed, it has the large roster many advisors and investors are accustomed with investment-grade muni ETFs. However, it’s not just roster size and yield that make HYD appealing.
HYD Details, Diversification Matter
For investors new to junk municipal bonds, it’s worth noting that some sectors are more prominent than others in this corner of the muni realm. Those include bonds tied to education institutions, healthcare, housing and industrial development, plus bonds with payments tethered to revenue states derive from tobacco settlements.
“These sectors share a common thread: repayment is tied to a specific project’s revenue (patient fees, tuition, rent) rather than a broad government tax base. That project-level dependence introduces additional credit risk, which is why these bonds carry lower ratings or go unrated,” according to VanEck.
In the grand scheme of things, junk-rated munis hailing from those sectors, broadly speaking, may prove to be only modestly riskier than investment-grade equivalents. However, investors may incur amplified risk if they attempt to identify the best opportunities in those segments on their own. That underscores the value of HYD’s broad-based approach.
Speaking of value, the ETF arguably doesn’t get enough credit for this value add: the diversification benefit tied to high yield municipal debt. That could be attractive to fixed income investors heavily allocated to Treasuries or investment-grade munis.
“High yield munis also offer diversification. The sectors driving this market (healthcare, education, housing) have very different economic drivers than the consumer cyclical, communications, and energy sectors dominating corporate high yield,” added VanEck. “That divergence means high yield munis can behave differently during market stress, potentially reducing overall portfolio volatility.”
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