Investors have been funneling money into exchange traded funds that provide exposure to high-yield corporate bonds. Junk bonds offer higher yields, but investors need to remember they’re being compensated for taking on more risk by moving into lower-quality debt.
High-yield ETFs have rebounded smartly along with U.S. stocks since the October 2011 market bottom, and defaults remain low.
Junk bond mutual funds and ETFs recently saw their first outflows following 18 straight weeks of inflows. [Investors Cool on High-Yield Bond ETFs]
The largest ETFs in the category include iShares iBoxx High Yield Fund (NYSEArca: HYG), SPDR Barclays High Yield Bond (NYSEArca: JNK), PowerShares High Yield Corporate (NYSEArca: PHB) and PIMCO 0-5 Year High Yield Corporate Bond (NYSEArca: HYS).
The iShares fund is yielding about 7%.
“Clients are essentially trying to replace the income they used to get from their government bonds,” said Hans Olsen, head of investment strategy in the Americas for Barclays Wealth, in a recent Bloomberg report.
However, investors need to remember high-yield corporate bonds have different risks than U.S. government debt.
Everyone is recommending junk bonds but they require extra research and care, junk bond trader Robert Levine told Bloomberg. “It’s not a no-brainer,” he said.
Aside from default risks, high-yield bonds may be overvalued after their strong run. If rates rise, the bond ETFs could also take a hit.
“There is a lot of money rushing into this space right now. As quickly as it came in, you could see that money flow out,” said Paul Jacobs, a financial planner at Palisades Hudson Financial Group.
During the first quarter of 2012, investors shoveled $31 billion into high-yield bond funds, according to the article.