Once the Federal Reserve decides it’s done making interest rate cuts, junk bond exchange traded funds (ETFs) could be a beneficiary. The appetite for risk goes up with economic recovery.

Gary Gordon for ETF Expert says that last year, he suggested a solution to the widening "credit spreads": invest in the iShares Lehman 7-10 Year Treasury Bond Fund (IEF) and short sell the iShares iBoxx High Yield Corporate Bond Fund (HYG).

Since he made his recommendation, IEF returned 15.5% and the short-selling hedge of HYG resulted in 0%. In effect, it neutralized the risk associated with a growing spread between junk bond funds (also called "high yields") and intermediate term U.S. treasury funds.

Meanwhile, the credit spread has grown: the difference between IEF’s annual yield and HYG’s in July 2007 was about 3%. Now, it’s above 4.5%. A widening spread can hint that investors aren’t exactly feeling bullish.

When the economic recovery begins, high yield bond funds could reap the rewards as the spreads tighten once again. HYG has a distribution yield of  8.3%. The SPDR Lehman High Yield Bond Fund (JNK) comes with an 8% distribution yield.


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.