Are High-Yield ETFs Also High Risk?
February 3rd, 2012 at 10:00am by Tom Lydon
Some investors looking to boost income are turning to high-yield exchange traded funds and other ETFs that invest in riskier bonds and alternative fixed-income sectors. As always, investors need to remember that higher yield usually means higher risk.
It’s understandable that some investors are reaching for yield with Treasury bonds, CDs and bank accounts offering such paltry yields. Furthermore, the Federal Reserve appears committed to keeping interest rates ultra-low for several more years. [Regulator Warns on 'Yield Chasing']
When investing in high-yield bond investments, people tend to focus on potentially higher volatility within the investment prices and the risk of default. However, since ETFs hold a large bundle of securities, any negative effects from defaults is largely diminished. [Investors Flocking to Emerging Market, High-Yield ETFs]
Most ETF providers disclose the credit worthiness of their bond holdings on their websites, an investor may judge whether or not he or she is willing to take on the exposure. Debt obligations with a bond rating of BB/Ba or lower are defined as “junk bonds” or “below-investment grade.”
Still, the funds may experience volatility associated with the macroeconomic fundamentals in the related markets. For instance, capital appreciation in international or emerging market dividend and bond ETFs will still reflect fundamental factors that affect global economies or region specific factors.
Other high-yielding instruments, such as master limited partnerships, real estate investment trusts or preferred stocks, require additional considerations. [Master Limited Partnership ETFs]
For example, the MLP structure allows them to pay out most of their revenue in the form of dividends to investors. REITs also have to pay out a large chunk of their revenue to investors so that they may qualify for government tax breaks. When looking at preferred stocks, the primary consideration should be their sector allocations – preferred stock ETFs are highly exposed to the financial sector. [Preferred Stock ETFs Enjoy Fat Yields, Capital Appreciation]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.