Fallen angel bonds, a higher quality derivative of traditional junk debt, offer investors the opportunity to generate income with high yields while possibly catching some capital appreciation along the way.
The S&P 500 is trading around 17 times earnings, its highest in seven years, David Giroux, T. Rowe Price Capital Appreciation manager, said in a Morningstar article.
On the fixed-income side, bonds are typically more attractive when stocks look somewhat expensive, but fixed-income assets have been pushed up, with interest rates still relatively low.
Consequently, Giroux believes that higher quality, speculative-grade debt may be one area where investors can find value.
“I would say the one area of both fixed income and equities where we see a little bit of value is what I would call the highest-quality high-yield bonds–companies that we think are sort of money-good, if you will, even in a difficult economic environment where you’re earning 4% to 5% for really high-quality BB bonds,” Giroux said in the article.
Investors interested in targeting this area of the market can take a look at the Market Vectors Fallen Angel High Yield Bond ETF (NYSEArca: ANGL), which tracks high-yield, junk bonds that were originally issued with an investment-grade rating. The fund has a 5.18 year duration and a 4.12% 30-day SEC yield. [Fallen Angel Bond ETF Offers Robust Yield]
ANGL offers a better debt profile than other high-yield funds. The ETF has a 73.2% allocation to BB-rated debt, 16.4% in B-rated debt and 6.0% in CCC-rated debt. Anything rated BB and below is considered speculative grade or junk. [Junk Bonds, ETFs See Default Rates Drop to 2008 Low]
The shift to income-oriented strategies over the past couple of years has pushed down yields and helped junk bonds rally.
“When we think about high-yield in general, we think high-yield is a little bit of a bubble, but most of that bubble is really on the CCC credits and the B credits, where spreads are well inside of history,” Giroux added. “We think the highest-quality BBs look attractive relative to equities and relative to the fixed-income market in general.”
In comparison, the more popular junk bond ETFs, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) include bonds with lower credit quality. HYG credit quality allocations include: BB 46.%, B 26.44% and below B 10.5%. JNK includes BB 38.8%, B 41.6% and CCC or lower 19.1%.
However, the tilt toward riskier debt provides higher yields. HYG has a 4.47% 30-day SEC yield and JNK has a 4.80% 30-day SEC yield.
For more information on speculative-grade debt, visit our junk bonds category.
Max Chen contributed to this article.