High-yield, junk bond exchange traded funds provide fixed-income portfolios with that extra kick, but investors should not go overboard with their exposure.
Interest rates remain stubbornly low, with benchmark 10-year Treasury yields still hovering around 2.45%. Consequently, more investors are looking at junk bond ETFs, like the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), which offer a 4.59% and 5.09% 30-day SEC yield, respectively.
Nevertheless, potential investors should remember that the more attractive returns come with greater risks. Specifically, these high-yield bond funds track speculative or junk rated corporate debt.
The bonds have also experienced more volatile swings. For the year ended July 2, high-yield bond funds attracted $3.2 billion in assets, reports John Wasik for the Wall Street Journal.
The positive sentiment soon soured as nervous investors pulled a record $7 billion out of junk-bond funds in the week ended August 13 – more money was pulled out of the bond funds in that single week than total inflows for most of the year. In the week ended August 20, investors rushed back in, piling $2 billion into junk bonds.
Due to their riskier nature, financial experts advise investors to keep junk bonds at no more than 5% of an income portfolio.
Additionally, advisors suggest coupling the riskier junk bonds with investment-grade debt to help smooth out the volatility. For instance, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) was only down 0.3% from the June 25 peak to the August 1 trough, whereas both JNK and HYG both dipped 3.5%. [High-Quality Corporate Bond ETFs Show Double-Digit Annual Returns]
Fixed-income assets will be negatively affected by a rising rate environment, but these funds have performing as rates declined this year. Additionally, corporate debt has been less vulnerable to rate spikes than U.S. Treasuries.
“Treasurys are most susceptible to price hits when rates rise,” Jeff Layman, chief investment officer at BKD Advisors, said in the article. “It’s unwise to buy Treasurys, even though the 10-year note has fallen in yield from about 3% to 2.4% this year. I don’t think this move is likely to repeat itself.”
Alternatively, investors can also consider a broad, all-in-one bond ETF for a simple way to gain diversified exposure to fixed-income assets. For instance, the Vanguard Total Bond Market ETF (NYSEArca: BND) includes 41.2% U.S. Treasuries, 20.0% corporate debt and 20.2% agency MBS pass-through debt. [Bolster Fixed-Income Positions With Corporate Debt ETFs]
For more information on speculative-grade debt, visit our junk bonds category.
Max Chen contributed to this article. Tom Lydon’s clients own shares of HYG, JNK and LQD.