ETF Face-Off: Floating-Rate Funds vs. Short-Duration High Yield
Our Key Takeaways
- The Fed has started to cut rates, which could lead to outflows for floating-rate funds.
- High-yield bonds seem better positioned for the range of possible interest-rate scenarios, and they seem stronger fundamentally, as they’re composed of higher-rated issuers than floating-rate bank loans.
- The pendulum could be swinging from floating-rate funds toward short-duration high-yield bonds as the optimal near-term credit allocation.
- We think the AB Short Duration High Yield ETF (NYSE: SYFI) is an attractive choice. It’s an active bond portfolio that seeks attractive income with less volatility than traditional high yield.
Falling Yields Favor Bonds, Not Floating-Rate Funds
Rising coupons on high-yield floating-rate funds were hailed as an antidote to rising rates when the Fed was tightening monetary policy. With the Fed now ready to change course, these funds may face pressure, and we think income seekers may wish to consider swapping into short-duration high-yield bonds.
Floating-rate funds seem riskier at this stage of the cycle: their variable coupons fall when rates fall. And with no duration, they don’t benefit from a price boost as yields decline—the way bonds do. The Fed started to cut rates in September, which could trigger investors to sell out of floating-rate funds.
Even in normal times, shorter-duration high-yield has the potential to deliver high income with lower volatility than intermediate-duration strategy. From 1989 through June 2024, the Bloomberg US High Yield 1–5 Year Ba/B Index returned 7.5% annualized with 6.1% volatility versus 7.1% and 8.6% for the Bloomberg US Corporate High Yield Index.
Fundamentals Matter: High-Yield Bonds Look Stronger
From a credit perspective, floating-rate funds may be facing strain today. Many floating rate borrowers saw financing costs rise along with interest rates, whereas most high-yield bond issuers had an opportunity to secure lower fixed financing costs before the Fed began hiking.
The high-yield bank-loan market, the predominant hunting ground of floating-rate funds, has seen its quality decline over the years. Today, 69% of the S&P LSTA Leveraged Loan Index is rated B or lower versus 46% in 2010. For the Bloomberg US Corporate High Yield Index, quality has improved, with its lower-rated share down to 49% from 62%. That could spell more credit risk for floating-rate funds.
We think high-yield bond fundamentals will likely weaken, with a slowing economy and higher financing costs, but we think default risk is mostly priced into markets for weak industries and individual issuers. And market fundamentals are starting from their strongest point since the 1990s. Still, avoiding defaults is particularly important today, given recent poor recovery rates. As we see it, this calls for an active hand at credit selection.
Investors with bank-loan exposure face a pressing question: Is the pendulum swinging from floating-rate funds toward short-duration high-yield bonds? We think it is, and the opportunity to rotate into short-duration high-yield bonds stands out.
SYFI: Seeking Attractive Income and Active Credit Management
Looking to pivot from floating-rate exposure into fixed-rate short-duration high-yield bonds to capitalize on the fleeting interest-rate opportunity? Explore the AB Short Duration High Yield ETF (NYSE: SYFI).
Its actively managed, research-driven bond portfolio seeks attractive income with less volatility than traditional high yield, and it dynamically manages risk through the credit cycle. Since inception, SYFI has avoided over 75% of US high-yield defaults, which could affect passive or less-skilled active strategies. On an annualized basis, the Portfolio’s default experience has been 0.1%, well below the roughly 3% for the Bloomberg US High Yield Index.
If you’re an investor looking for trading guidance, the AB ETF Capital Markets team offers complementary trade advisory services. You can reach us at etf.capitalmarkets@alliancebernstein.com. And you can find out more about AB’s actively managed ETFs here.
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