With fixed-income yields as low as they are now, the yields on junk bonds are looking quite attractive. However, junk bond exchange traded funds (ETFs) might be at risk of crumbling if the economy takes another hit.
Junk bonds have been hugely popular for a big chunk of this year, and the market has shown few signs of tapering off. Case in point: junk bond mutual funds have only had one week of outflows since early July, The Wall Street Journal reports.
Robert Huebscher for Advisor Perspectives remarks that you should avoid junk bonds if you believe there is a greater than 21% chance that a severe economic downturn is coming. Still, high-yield bonds have been a good diversifier when combined with equities and investment-grade corporate bonds.
Historically, high-yield bonds have performed well when default rates remained low – which they are right now. Moody’s factored in a recovering economy and projects a default rate of 2.2% for the U.S. market. However, the market’s estimated default rate is 2.97%. [How to Cope With Junk Bond ETF Risk.]