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.]
Additionally, interest rates and the spread to the Treasury market are also factors that affect high-yield bonds. Currently, spreads on most higher-quality junk bonds are wider than their historical means.
It’s true that high-yield debt is among the riskiest types. If this is an uptrend you want to get in on, you can help mitigate this risk by implementing a simple strategy such as trend following, and/or set up trading alerts to be notified by email when a sell signal is reached.
For more information on high-yield bonds, visit our high-yield bonds category.
- iShares iBoxx $ High Yield Corporate Bond (NYSEArca: HYG): yields 7.77%
- SPDR Barclays Capital High-Yield Bond (NYSEArca: JNK): yields 8.44%
- PowerShares Fundamental High Yield Corporate Bond (NYSEArca: PHB): yields 6.82%
For full disclosure, Tom Lydon’s clients own shares of JNK.
Max Chen contributed to this article.