I’m often asked why I recommend a particular exchange-traded fund (ETF), tracking a specific niche of the bond or credit markets, over another.

Dozens of factors come into play including portfolio composition and concentration, credit exposures, expense ratios, duration and yield. And, of course, there’s no golden factor or metric that can be used to identify the best-performing ETF in every economic or market environment.

However, when weighing the relative merits of a group of ETFs in a specific niche, I’ve found the Sharpe ratio to be a useful metric to include in my analysis.

Let me explain the meaning of this ratio and how it can be used to compare four ETFs I monitor tracking US high-yield bonds.

Sleep-Easy Yields

If you’re interested in the type of fixed income, credit and preferred stock ETFs I cover in Smart Bonds, you’re probably looking to generate yield, and regular distribution income, from your portfolio.

However, just as important, you’re also looking to generate income without losing too much sleep.

After all, for centuries, investors have looked to these markets as a means of generating hefty income without the level of risk, and day-to-day volatility, that’s characteristic of equities.

That’s why I frequently write about the volatility of a particular ETF or niche of the bond market relative to the volatility of the S&P 500, the Bloomberg Aggregate Bond Index or some other popular investment benchmark.

That’s the gist of the Sharpe ratio and a second, similar metric called the Sortino ratio I’ll cover in just a moment.

Nobel laureate William Sharpe developed the Sharpe ratio in 1966, originally calling it the reward-to-variability ratio. Simply put, it’s a way of evaluating the amount of return an asset (in this case an ETF) generates compared to the volatility (a measure of risk) of that asset.

It’s calculated as the ratio of average excess returns from a particular asset over the risk-free rate (a portfolio of short-term government bonds) divided by the volatility of the asset. The higher the Sharpe ratio, the more return you’re getting relative to the risk and volatility you endure in the asset.

The best way to illustrate is with an example:

High Yield and Fallen Angels

Over the past two weeks I’ve spilled significant digital ink on the global high-yield or “junk” bond market and my favorite niche of this market, known as the fallen angels. If you missed these discussions, check out the video I published on July 15^th called “The High-Yield Sweet Spot,” as well as last week’s issue and update titled “Rate Sensitivity and Credit Risk.”

So, let’s take a closer look at the Sharpe ratio for four popular ETFs in the high-yield bond niche.

The two most widely held fallen angels ETFs are the iShares Fallen Angels ETF (NSDQ: FALN) I recommend in the Smart Bonds model portfolio and the VanEck Fallen Angels High Yield Bond ETF (NSDQ: ANGL). And the two most widely followed ETFs tracking the broader high-yield bond market are the iShares iBoxx High Yield Corporate (NYSE: HYG) ETF and the SPDR Bloomberg High Yield Bond ETF (NYSE: JNK).

The US bond market joined the stock market in having a rough year in 2022 with both the Bloomberg Aggregate US Bond Index and the S&P 500 finding a low in October 2022. So, let’s evaluate the Sharpe ratio for our four high-yield bond ETFs using weekly data since September 2022. To calculate the risk-free rate, I’ll use returns from the iShares 0-3 Month Treasury Bond ETF (NYSE: SGOV), an ETF that tracks short-term US government bonds (Treasury Bills).

Let’s start with this:

Source: Yahoo Finance Retrieved Using Python Script

As you can see, the return from the risk-free asset – I’m using the SGOV ETF – was about 14.4% over this period with the four high-yield bond funds I’m evaluating offering returns of between 31.3% for the ANGL fund to 33.9% for FALN over the same time.

These are just raw total returns (not annualized) including all distributions (all five ETFs in my chart pay distributions monthly) and capital gains over this holding period.

While there have certainly been some nasty sell-offs in the US bond market since late 2022 – the autumn of 2023 is a notable example – this period has generally represented a bull market for the US corporate bond market including the high-yield bond niches covered by the four ETFs on my chart.

Here are the annualized Sharpe ratios calculated using weekly returns for the four high-yield ETFs over this same period:

Source: Calculated Using data retrieved from Yahoo Finance with a Python Script

As you can see, the high-yield bond ETF I recommend in the model portfolio, the FALN fund, has the highest Sharpe ratio of any of the four ETFs on this table while the ANGL fund, which tracks the same fallen angels niche of the high-yield bond market, has the lowest.

The final column on this table shows the Sortino ratio. The calculation is similar to the Sharpe ratio except instead of evaluating standard deviation of portfolio returns across all periods, the Sortino Ratio only takes downside volatility into account. The idea is that most investors aren’t concerned about upside/positive volatility from an ETF or index, only negative volatility (losing money).

On a Sortino ratio basis, the two pure high yield bond ETFs offer the highest ratios. FALN is mid-pack at a respectable 1.36 and ANGL lags at 1.16.

Of course, Sharpe and Sortino ratios will vary significantly depending upon the period over which they’re evaluated. That’s why I like to evaluate these ratios through different market environments and different historical periods.

So, let’s look at a longer-term dataset:

Source: Calculated Using data retrieved from Yahoo Finance with a Python Script

FALN was listed for trading back in mid-2016, so I’m evaluating the same four ETFs over the period from late June 2016 through to the end of 2021, just before the start of the coordinated stock and bond market sell-off in 2022.

The interesting feature of this chart is that, contrary to the experience of the period since the autumn of 2022, the fallen angels ETFs – that’s FALN and ANGL – offered superior return-to-risk ratios than the pure high yield fixed income ETFs, HYG and JNK.

That’s consistent with several research papers published over the years showing that fallen angels offer superior returns and lower volatility over the long haul compared to the broader “junk” bond universe.

Finally, let’s look at the Sharpe and Sortino ratios for all four of these ETFs over the trailing 52- and 104-week periods (1- and 2-year holding periods):

Source: Calculated Using data retrieved from Yahoo Finance with a Python Script

On this table I’ve also included returns from the risk-free asset – I’m using the iShares 0-3 Month Treasury Bond ETF (NSDQ: SGOV) in this case – and the returns, Sharpe and Sortino ratios for the iShares Core US Aggregate Bond ETF (NYSE: AGG). AGG tracks a Bloomberg Index of US bond market performance that includes a mix of Treasury, investment grade corporate, mortgage and other bonds traded in the US.

There’s a lot more to selecting ETFs for the model portfolio than just returns and ratios, however, here’s how I parse this data to favor FALN in the model portfolio right now.

Focus on Performance Through the Cycles

Smart Bonds is a longer-term oriented investment portfolio.

I seek to generate significant yield income via monthly distributions while keeping risk and volatility in check. I also seek to minimize portfolio turnover.

The model portfolios in this service are active and when markets are volatile or there are significant new trends underway, I make more frequent adjustments including new additions to, and sales from, the portfolios. For example, through the first 5 months of 2025 I added significant exposure to global bond markets in the model portfolios because returns from those markets have exceeded what’s available in most segments of the US bond market.

This is a powerful, nascent trend in fixed income that I believe could be part of a multiyear rotation. It’s something I covered at more depth in the March 14, 2025 issue “The Economy, Credit Spreads and Global Rotation,” as well as in the May 9^th issue “Buying Abroad,” and in my April 22^nd video “The Global Bond Bull Market.” To fully take advantage of this trend, something that’s been a significant boost to overall portfolio returns in 2025, we needed to make some significant adjustments to the model portfolio.

However, I don’t recommend new ETFs with the intention of selling out for a quick gain in a few months’ time. That’s because, in most cases, your returns from bond, credit and preferred stock ETFs will accrue over time through a combination of distributions and, in some cases, capital gains.

Sharpe and Sortino ratios calculated over short holding periods are volatile and reflect plenty of market noise that’s meaningless to an intermediate to long-term investor. So, I tend to place more weight on metrics measured over longer periods.

In the last few issues of Smart Bonds, I outlined some of the reasons why I like the high-yield bond market right now. That list includes high-yield bonds’ reduced sensitivity to rates and the 10-Year Treasury yield as well as the tendency for high-yield bonds to offer superior returns when stock market volatility is relatively low and when the risk of imminent recession is contained.

Then, it’s a matter of choosing between the myriad high-yield bond ETFs on offer in the US including the four I’ve included in my tables this week.

Look at my table above and you’ll notice that FALN has the second-lowest return of any of the high-yield ETFs over the past year and the worst Sharpe and Sortino ratios over the past 52 weeks. While FALN has handily outperformed our risk-free asset – SGOV on my table – and has trounced the broader US bond market, measured by AAG, it has offered lower risk-adjusted returns on these metrics than ANGL, JNK and HYG.

I just don’t put much weight in that metric because the time frame is too short to tell us much.

Over the past 52 weeks, fixed income markets have been laser-focused on interest rate risk and the impact of high Treasury bond supply – the US government’s elevated financing needs – on long-term yields. There have been a couple of minor flare-ups in concerns about recession and credit risk – in early August 2024 and March-April of this year – however duration and interest rate risk have dominated.

As I explained in the past few issues, the two fallen angels ETFs in my tables above track bonds with higher average credit quality (just below investment grade) and slightly higher effective duration. Both traits give FALN and ANGL (slightly) more rate sensitivity than HYG and JNK.

This point is crucial: FALN and ANGL both have lower exposure to interest rate risk than the broader US bonds market tracked by AGG, most of the investment grade corporate bond ETFs I track or, of course, intermediate and long-term Treasury ETFs.

Over slightly longer periods the market has gone through phases of concern about the economy, rates and various other factors. Accordingly, through the recent bond bull market cycle — the period since late 2022 I outlined at the beginning of this issue — FALN offered superior returns to the other high-yield ETFs in my coverage universe.

And if we look at the even longer period from mid-2016 through the end of 2021 – a period that included recession scares like late 2018, an actual recession in 2020, economic booms like 2021 and periods of ultra-low market volatility like 2017 – the two fallen angels ETFs offered superior risk-adjusted and absolute returns to HYG and JNK.

As I noted that result has also been the subject of several papers published over the past three decades indicating superior returns from fallen angels ETFs. So, given the longer-term evidence, I favor fallen angel ETFs like FALN and ANGL over general high-yield bond ETFs like HYG and JNK in most market environments.

Of course, there’s a chance that something fundamental has changed that will impact the relative performance of fallen angels and pure high-yield ETFs in future – historical results are never a perfect guide for the future. However, one year of data is not enough time to invalidate the longer-term superior absolute and risk-adjusted performance of fallen angels or indeed superior performance from FALN since the start of the current cycle in late 2022.

Finally, given its edge in terms of absolute and risk-adjusted returns through the current cycle and over the past two years I give the nod to FALN in the model portfolio over ANGL.

As I said at the beginning of this issue, a lot more goes into selecting ETFs for the model portfolios and it’s far from an exact science. However, comparing risk and return characteristics through the cycle and in light of the current economic and market environment are always part of the process.

Interested in more? Consider signing up for my Smart Bonds report here to find out how to gain instant exposure to high-yield and low-volatility markets inaccessible to individual investors just a few years ago.

 

DISCLAIMER: This article is not investment advice and represents the opinions of its author, Elliott Gue. Smart Bonds is NOT a securities broker/dealer or an investment advisor. You are responsible for your own investment decisions. All information contained in our newsletters and posts should be independently verified with the companies mentioned, and readers should always conduct their own research and due diligence and consider obtaining professional advice before making any investment decision.