USD High Yield Bond ETF (Currency Hedged)

Sometimes called “sub-investment grade”, high yield bonds are tradeable debt securities issued by companies with sub-investment grade credit ratings, as judged by ratings agencies. High yield bonds typically have ratings of or below “BBB-” by Standard & Poor’s Ratings Services and Fitch, or “Baa3” by Moody’s Investors Services. They are often thought to come with higher risk and higher potential rewards than investment grade bonds.

USHY is passively managed. It tracks an index of high yield bonds managed by the German index provider Solactive. To qualify for index inclusion, bonds must meet all of the following criteria:

(i) They must be issued by companies based in developed market countries, as defined by Solactive.

(ii) Issuers must have a composite credit rating of sub-investment grade, as judged by ratings agencies S&P, Fitch and Moody’s.

(iii) Bonds must be issued by companies with at least US$1 billion outstanding face value.

(iv) Bonds must have at least US$400 million of outstanding face value.

(v) Bonds must have a maturity date of 15 years maximum at the time of issue.

(vi) Bonds must have more than 12 months to maturity (or at least 20 months for bonds new to the index).

Each company’s debt will be capped at 3% of the fund’s weight. The index rebalances monthly.

Due to the size of the bond market, it is often impractical or impossible for index-tracking bond funds like USHY to buy every bond in their index. For this reason, index-tracking bond funds commonly take a selection or “sample” of bonds from their indices—in a method known as “sampling replication”. Bonds will be chosen in order to replicate the index as closely as possible, based on risk and return characteristics.

One of the attractions of bonds as an asset class is that they provide capital stability and steady income. Yet when investors buy unhedged bonds denominated in foreign currencies, currency fluctuations mean there is a greater risk of capital loss and income erosion. In order to support capital stability and make income payments more consistent, we have chosen to use currency hedging for USHY.

When volatility rises, high yield bonds can provide a steady income that smooths portfolio volatility without excessively sacrificing returns. Historically, high yield coupons have been stable in all kinds of markets.

Diversification is an added benefit. Like other kinds of bonds, high yield bonds have a low correlation to equities. This can mean they offer a possible hedge during share market corrections and bear markets.

Access is also a benefit. The corporate bond market is different from the share market in that it is “over the counter”. This means it is made up of banks and brokers trading directly with each other. Much of the high yield bond market is essentially off-limits to smaller investors. USHY, therefore, provides an accessible vehicle to a potentially rewarded asset class that is unavailable to many investors directly.

USHY is issued and managed by Global X but gains its exposure to the underlying high yield bonds via an ETF issued and managed by DWS. USHY buys and sells units in the US-listed Xtrackers USD High Yield Corporate Bond ETF (Ticker: HYLB), and manages this exposure to ensure the fund tracks the index as closely as possible. HYLB tracks the same index of high yield bonds, but is not hedged to Australian dollars. Global X separately manages the currency hedging.

Three major risks to high yield bond ETFs include credit risk, liquidity risk and interest rate risk. These three risks by no means exhaust the full set of risks faced by the fund. (For more detail, please read the product disclosure statement). To summarise each:

Credit risk. The fund could suffer if a company whose debts it holds defaults, has its credit rating downgraded, or is unable to meet a financial obligation. Credit risk is higher for higher yield bonds because the companies issuing them are of less certain financial health.

Liquidity risk. High yield bonds are less liquid than investment grade bonds. Some rarely trade; others never trade at all. Bonds included in USHY have been screened for liquidity. However, the illiquidity of high yield bonds poses a number of risks to the fund nonetheless. These include an inability to sell the bonds it holds for cash. The inability to accurately value the fund. And the possibility of the fund trading at a discount to its net asset value. These risks will be higher in times of elevated volatility.

Interest rate risk. When interest rates rise, prices of debt securities typically fall. (The vulnerability of debt securities to interest rate rises is commonly measured by a statistic called “duration”). This means that changes in monetary policy by central banks or governments are likely to affect the performance of the fund.