Now despite the low volatility and high income from these ETFs, there are still several risks lurking beneath the surface. The high yield market has blossomed over the past several years due in large part to below average default rates. However, several experts are predicting that we may see an uptick in defaults as well as spread compression if the economy hits a rough patch. This would cause the value of high yield bonds to fall and likely spur a rally into higher rated securities such as Treasuries or cash.
How to Profit From High Yield Bonds
As a trend follower I am always monitoring my investments in relation to their historical price patterns. As you can see on the HYS chart above, the upward trend in still intact and I am continuing to hold an allocation to this sector for capital appreciation and income. For clients in my income portfolio, I have selected the Osterweis Strategic Income Fund (OSTIX) as an actively managed high yield mutual fund equivalent. This fund also has modest exposure to convertible bonds as well.
If you already have an allocation to these investments or similar holdings, then I would recommend continuing to ride their success until we see a change in character. New money can be introduced on any modest pullbacks to enter new positions or reallocate existing capital. You should size your positions in line with your risk tolerance and may want to consider pairing high yield with high quality bond positions in order to offset the credit risk in your portfolio.
Going forward I will be monitoring credit spreads, interest rate changes, default rates, and volatility in the context of a risk management plan to stay on top of the changing high yield landscape. If a trend change starts to develop, I won’t hesitate to downsize or remove this sector entirely from the portfolio in order to actively shift my holdings into areas of the market that are performing in a superior capacity.
David Fabian is the chief operating officer at Fabian Capital Management LLC.