Junk bond exchange traded funds provide attractive yields, but the asset class category exposes investors to specific credit risks.
The yield on speculative grade debt depends on the time horizon for when the bond is repaid and the creditworthiness of the issuer, writes John Waggoner for USA Today.
As a junk bond, the debt security is rated from BB to D, or default. Anything rated BBB and above is considered investment grade.
Speculative grade debt has been popular in a low interest rate environment as a high-yield option for income investors, despite the greater risk of defaults. [High-Yield Bond ETFs and Rising Rates]
“The economy is OK, autos and housing are good,” Mark Durbiano, manager of Federated High Income Bond, said in the article. “They have a lot of cash flow, and there’s nothing crazy on the balance sheet side.”
This debt category has been holding up as interest rates inched up this year – junk bonds are correlated to stocks and do well in an improving economy.
“If you think there’s going to be a recession or an equity market bear market, don’t buy high yield,” Durbiano added. “If you think the economy is OK, high yield is where you want to be.”
The average junk-bond fund showed a 2.9% return this year, whereas the average intermediate-term bond fund lost 3.1%, according to Morningstar. Meanwhile, the yield on the Barclays High-Yield Bond Index is a little below five percentage points higher than comparable Treasuries. The high yields also help offset any downside due to rising rates. [Shorting Treasuries Helps Active High-Yield ETF]
“Those higher coupons are going to potentially insulate some of the negative price action of a rising rate environment,” Jennifer Vail, head of fixed income for U.S. Bank Wealth Management, said in the article.
Investors interested in high-yield, junk bonds can take a look at a couple ETF options, including the iShares iBoxx High Yield Corporate Bond (NYSEArca: HYG) and SPDR Barclays High Yield Bond (NYSEArca: JNK). HYG has a 4.22 year duration and a 5.56% 30-day SEC yield, and JNK has a 4.45 year duration and a 5.88% 30-day SEC yield. Additionally, investors can trade off yields for a safer, lower duration found in the PIMCO 0-5 Year High Yield Corporate Bond Index ETF (NYSEArca: HYS), which has a 2.03 year duration and a 3.70% 30-day SEC yield.
For more information on speculative grade debt, visit our junk bonds category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own HYG and JNK.