Treasury yields are climbing fast, and some of the most popular income ETFs on the market are quietly becoming traps for unsuspecting investors chasing yield.
The economy is at a crossroads today, with Treasury yields climbing higher and higher as the U.S. government remains unyielding in its resolve to keep markets hot. ETFs like the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG), iShares Preferred and Income Securities ETF (NASDAQ:PFF), and the JPMorgan Nasdaq Equity Premium Income ETF (NASDAQ:JEPQ) are worth looking into if you want to de-risk your portfolio.
Interest rate hikes to cool the market will be politically controversial, and depending on how midterms go, it might only get worse from here.
That’s why it’s a good idea to dump some ETFs from your portfolio as we enter stormy waters. ETFs that rely heavily on yields are usually the ones most sensitive to high Treasury yields and market shocks.
This is because Treasury yields are often considered a “safe” benchmark. When you have an ETF that trades flat and gives you a 5% yield, it no longer looks solid compared to a bond that also trades flat, has little downside risk, and gives you a 4.8% yield.
That fact will cause many ETFs to start declining in value if high Treasury yields normalize and the government stays comfortable with inflation running high.
Here are the three ETFs to reconsider.
iShares iBoxx $ High Yield Corporate Bond ETF (HYG)
HYG owns the debt of companies with below-investment-grade credit ratings, which means it owns junk bonds. And plenty of people are happy to hold it due to its 5.99% dividend yield and monthly payout frequency.
But even that yield is starting to fall short as Treasury yields climb back to near record highs.
If you own HYG, you’re taking significantly more risk for a little more yield. The debt inside HYG is issued by companies with weak balance sheets and heavy debt loads, and they often have cyclical businesses. Obviously, HYG is not stuffed entirely with companies teetering over the abyss. Most of the portfolio sits in BB debt, which is the uppermost ledge of junk credit. Nevertheless, almost 40% is rated B or worse.
On top of that, the expense ratio is 0.49%, which is much higher than what you’d pay for a Treasury ETF like TLT (NASDAQ:TLT). TLT charges just 0.15%. HYG only makes sense if you are confident the economy is set to keep running hot with no recession in sight.
iShares Preferred and Income Securities ETF (PFF)
PFF is essentially cut from the same cloth as HYG. Companies often issue preferred shares to raise cash. These preferred shares don’t come with voting rights, but they position you ahead of common shareholders in case a company goes bankrupt.
That’s rather ornamental, because preferreds are still behind every class of debt. You’re therefore getting deeply subordinated debt with fixed dividends and limited capital appreciation (these shares have a par value). Worse, they can go down significantly during a recession, so you’re left with bond-like upside and equity-like vulnerability. There’s a reason why Benjamin Graham saw preferred stocks as a good option only when they traded at significant discounts. For most of these stocks today, that’s not the case.
PFF pays monthly and yields 5.41%. The expense ratio here is 0.45%.
JPMorgan Nasdaq Equity Premium Income ETF (JEPQ)
The JEPQ ETF turns the market’s volatility into income, and that has gone quite swimmingly for holders over the past few years. JEPQ is essentially built for a nonstop uptrend that goes on for years, but the moment things normalize, it can prove devastating for your portfolio. There’s a reason why these sorts of ETFs have gotten so popular only in the past few years.
First things first, JEPQ gives you “exposure” to the same stocks you hold in your growth portfolio. Investors with two separate baskets of ETFs for growth and dividends likely have JEPQ in the dividend basket, which is the wrong place to put it due to its growth holdings.
And second, the past few years have proven that you’re better off just holding the raw Nasdaq-100 (NASDAQ:QQQM) and selling out of it if need be.
I’d only buy JEPQ if you are deep into retirement and no longer have time to think about selling stocks. Even then, it’s not a good deal as Treasury yields climb. If growth stocks correct by even 15-20% from here, an ETF like JEPQ would take much longer to recover because of its capped upside.
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