High-yield debt managers have consistently left money on the table. Industry research suggests passive high-yield strategies have shown persistent underperformance compared to broad market indices over extended periods—a pattern that has persisted across market cycles. In an interview with The Wealth Advisor’s Scott Martin, Michael Schlembach, Managing Director and Portfolio Manager, High Yield, at Marathon Asset Management, calls this concept “forfeited return.”
The John Hancock High Yield ETF (ticker: JHHY) seeks to address the passive strategy underperformance through a fundamentally different approach to high-yield portfolio construction. As Schlembach says, this strategy is “the result of a terrific relationship” between Marathon Asset Management, subadvisor since the fund’s May 2024 launch, and Manulife John Hancock Investments. Rather than accepting the traditional trade-offs between passive tracking and active management, he explains, JHHY is built on a process that aims to deliver the full return potential of high-yield debt while seeking to maintain low tracking error relative to the benchmark.
The Evolution of High-Yield Liquidity
The high-yield market has undergone a structural transformation that most managers have been slow to recognize. Where liquidity was once “very narrow but very deep,” concentrated among 10 to 15 major issuers that could be traded in size, Schlembach says, the growth of passive ETF assets has fundamentally altered the market’s liquidity profile.
“As more passive ETF assets have grown and more ETF assets in general have grown, the market continues to move towards a liquidity profile that’s much more broad, but it’s much shallower,” he explains. The percentage of bonds that don’t trade in a given month has dropped from north of 10% to south of a couple of percent over the past five to 10 years, creating new opportunities for portfolio construction that many active managers haven’t fully exploited.
JHHY’s process capitalizes on the evolving correlation patterns within high-yield bonds. Schlembach notes how, for example, two bonds trading above par, even in different industries, can exhibit correlation as high as 0.8 over a two-year-forward period. Meanwhile, two bonds in the same industry trading at 60 cents on the dollar may show correlation closer to zero—or even negative. Understanding and exploiting the correlation dynamics forms the foundation of JHHY’s approach, allowing the team to target sector exposure through liquid names while selectively targeting opportunities in the market’s less liquid segments.
“What we are able to do is use that larger, more liquid space to express some industry tilts—sectors we like or don’t like—and then look at that tail of the market with a thought towards what it is in the index,” he adds.
A Resource-Intensive Dual Approach
Marathon’s investment process reflects the firm’s broader credit focus, with approximately half of the firm’s assets in public credit and half in private credit. The high-yield strategy leverages a team of a dozen professionals covering the regular-way segment of the market with broad sector expertise, while an additional 10–15 people focus exclusively on opportunistic credit, examining five to seven issuers at a time rather than entire industries.
“The way we think about this is we want to push down the responsibility at that sector level to the person or persons that have been covering those sectors for decades,” says Schlembach. The senior-level team averages almost 20 years of experience across sectors such as healthcare, energy, financials, and telecommunications—expertise that proves crucial when evaluating relative value in complex credit markets.
The monthly process begins with sector-level analysis, where specialists provide views ranging from “underweight three” to “overweight three” based on their assessment of relative value over the next three to six months. The JHHY team then fills approximately three-quarters of each sector allocation through liquid, correlated issuers, using the remaining portion for positions on more idiosyncratic, often stressed and distressed names identified by the opportunistic team.
Redefining Risk Management
Traditional active management in high yield has often meant accepting higher tracking error—a measure of how closely a portfolio’s returns follow those of its benchmark—in exchange for the potential for outperformance. JHHY’s approach recognizes an asymmetry in how managers typically view position risk, challenging the conventional wisdom that portfolio risk stems only from securities you own. “There is risk in not owning something just like there is risk in owning something,” Schlembach emphasizes. “So, in our mindset, if something doesn’t look like the index and we don’t own it,” the fund is essentially shorting it relative to the benchmark.
The Marathon process aims to construct a portfolio that represents a subset of the market with duration and spread characteristics similar to the benchmark’s, resulting in relatively low tracking error. “We aim to reduce the surprise factor of what the fund might deliver compared to a benchmark,” explains Schlembach, and create “more like a dimmer than a light switch” to provide flexibility in portfolio allocation rather than requiring all-or-nothing decisions about high-yield exposure.
“We want to make sure that we deliver the value of the high-yield asset class,” he stresses. Rather than making oversize bets on individual names outside the benchmark, Marathon understands its role as providing pure high-yield exposure while leaving alternative strategies to other investment vehicles. “So, we view what we do here as a way of allowing an advisor or a firm or an allocator to throttle their allocation to the asset class.”
The fund’s opportunistic component can scale positions appropriately based on conviction and opportunity size. When the opportunistic team identifies a compelling situation where they can drive terms and participate in creditor negotiations, position sizes may increase to 30 basis points rather than the typical 15–basis point index weight. However, the strategy maintains its commitment to representing the high-yield asset class rather than making concentrated bets outside the benchmark.
Current Market Positioning
JHHY’s current positioning reflects both structural changes in high-yield credit quality and tactical responses to market conditions. The double-B cohort has grown from 37% coming out of the financial crisis to almost 55% today, contributing to successively lower spread peaks during each of the past four volatility waves. The team has been able to capitalize on rotational opportunities, such as the spread widening in March and April, while adjusting positioning as relationships have normalized.
“What we’ve been able to do is what I call leaning into a mix of duration, quality, and liquidity, three things that, regardless of where you are in high yield, are really hard to find,” Schlembach observes. The team has identified attractive opportunities in subordinated debt issued by investment-grade-rated companies—securities offering 6.5% to 7.25% coupons callable for 10 years with reset mechanisms that could provide additional upside if rates remain elevated.
One area requiring particular caution involves high-yield securities that have recently been downgraded from investment grade. Unlike historical patterns where these fallen angels traded at discounts reflecting their recent downgrades, the current cohort appears fundamentally weaker—with the 25th-percentile fallen angel carrying almost nine times leverage—yet trades at premiums to the broader BB-rated universe.
“We do see a lot of fallen angel strategies in some advisor portfolios, and we might suggest that broad high yield is a better proxy for what they might be trying to achieve instead of a fallen angel strategy,” Schlembach says. Adding that “‘safe’ does not always equal conservative,” he draws parallels to long-duration treasuries that were considered conservative but proved unsafe during the 2022 rate hiking cycle.
Portfolio Integration and Client Outcomes
JHHY’s duration profile, currently at approximately three years, positions it as a potentially compelling core high-yield allocation to integrate with existing fixed income strategies. Given the strategy’s approach of targeting duration and spread characteristics similar to those of the benchmark, it aims to serve multiple roles within client portfolios—as a complete high-yield allocation, as part of a barbell strategy with more defensive fixed income, or as a yield-enhancing component within investment-grade bond ladders.
“We work really, really, really hard as a unit here to never come up in a meeting as it relates to this product,” notes Schlembach. The team seeks to deliver consistent performance while avoiding the negative surprise factor that can derail client relationships. “There’s no deviation from our process,” he emphasizes. “It’s own good high-yield bonds. It’s an underwriting process at the sector and individual security level. It is consistent rebalancing for opportunities that present themselves. And it’s in that consistency that we think we deserve consideration as a core high-yield allocation.”
Looking Ahead
As the Federal Reserve’s rate-cutting cycle potentially unfolds, high yield’s role in income replacement becomes increasingly relevant. The asset class has delivered a high-6% annualized return over the past two decades with two-thirds the volatility of equities, strong compounding income characteristics, and daily liquidity.
“We think high yield is a part of that solution. It’s not the entire solution,” Schlembach notes, considering the asset class as a potential core component of investors’ response to a lower-rate environment.
JHHY’s systematic approach to high-yield management represents an evolution in active management of the asset class. By combining deep sector knowledge, opportunistic credit capabilities, and a disciplined rebalancing process, JHHY seeks to capture the full return potential of high-yield debt while maintaining the risk characteristics advisors expect from their core fixed-income allocations.
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Additional Resources
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Disclosures
This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector, or index. No forecasts are guaranteed. The information contained here is based on sources believed to be reliable, but it is neither all inclusive nor guaranteed by John Hancock Investment Management.
John Hancock Investment Management is not affiliated with Wealth Advisor.
The Intercontinental Exchange (ICE) Bank of America (BofA) U.S. High Yield Constrained Index tracks the performance of globally issued, U.S. dollar-denominated high-yield bonds with exposure to each issuer capped at 2%. It is not possible to invest directly in an index.
Diversification does not guarantee a profit or eliminate the risk of a loss.
Investing involves risks, including the potential loss of principal. There is no guarantee that a fund’s investment strategy will be successful. Fixed-income investments are subject to interest-rate and credit risk; their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments. Investments in higher-yielding, lower-rated securities include a higher risk of default. It is possible that an active trading market for fund shares will not develop, which may hurt your ability to buy or sell fund shares, particularly in times of market stress. Trading securities actively can increase transaction costs, therefore lowering performance and taxable distributions. Foreign investing has additional risks, such as currency and market volatility and political and social instability. Liquidity—the extent to which a security may be sold or a derivative position closed without negatively affecting its market value, if at all—may be impaired by reduced trading volume, heightened volatility, rising interest rates, and other market conditions. The use of hedging and derivatives could produce disproportionate gains or losses and may increase costs. Fund distributions generally depend on income from underlying investments and may vary or cease altogether in the future. Shares may trade at a premium or discount to their NAV in the secondary market. These variations may be greater when markets are volatile or subject to unusual conditions. There can be no assurance that active trading markets for the shares will develop or be maintained by market makers or authorized participants. Please see the fund’s prospectus for additional risks.
Clients should read and carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. To request a prospectus or summary prospectus with this and other important information, call us at 800-225-6020, or visit us at jhinvestments.com/etf.
John Hancock ETFs are distributed by Foreside Fund Services, LLC in the United States, and are subadvised by Boston Partners, Dimensional Fund Advisors LP, Marathon Asset Management, or our affiliates Manulife Investment Management (US) LLC, and CQS (US), LLC. Foreside is not affiliated with John Hancock Investment Management Distributors LLC, Manulife Investment Management (US) LLC, CQS (US), LLC, Boston Partners, Dimensional Fund Advisors LP, or Marathon Asset Management.
NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE. NOT INSURED BY ANY GOVERNMENT AGENCY.
THIS MATERIAL IS FOR INSTITUTIONAL/BROKER-DEALER USE ONLY. NOT FOR DISTRIBUTION OR USE WITH THE PUBLIC.
JHS-799660-2025-09-05 09/25
