Fixed-income investors should not chase after yields as returns do not reflect risks. Instead, people should stick to quality, like investment-grade corporate debt and bond-related exchange traded funds.
With benchmark 10-year Treasury yields back down to about 1.8%, there is a greater chance of rates rising than falling lower. [The ETF Income Conundrum: Balancing Yield and Risk]
“Long term, there is only one direction rates can go from here,” Lane Jones, chief investment officer at Evensky and Katz/Foldes Financial Wealth Management, said in a CNBC article. “Our approach is to remain defensive and not reach for yield.”
Many may look at high-yield corporate bonds as an attractive alternative to the paltry yields in U.S. government bonds. For example, the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) has a 6.11% 30-day SEC yield and iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) has a 5.52% 30-day SEC yield. [Corporate Bond ETFs: Oil-Induced Default Risks Are Overblown]
Additionally, some may think that these junk bond ETFs may be cheap, especially after the recent pullback late last year. However, the yield premium over Treasuries and investment-grade corporate bonds remain historically low.
You’re not getting paid much for the extra risk,” Jacob Wolkowitz, investment manager at Accredited Investors, warned.
On the other hand, investment-grade corporate bonds may be a decent play to capture quality debt with decent yields. For instance, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) has a 2.85% 30-day SEC yield, Vanguard Intermediate-Term Corporate Bond ETF (NYSEArca: VCIT) has a 2.91% 30-day SEC yield, and SPDR Barclays Intermediate Term Corporate Bond ETF (NYSEArca: ITR) has a 2.16% 30-day SEC yield. [ETFs for a Deflationary Period]
Corporate bonds also have a greater correlation to U.S. companies or slightly greater volatility than U.S. Treasuries. However, Corporate America is sitting on huge cash stockpiles, which diminishes default risks.
“The last time an investment-grade rated company defaulted was 2011, and the average default rate since 1981 for investment-grade debt is 0.12%, according to S&P’s 2013 Annual U.S. Corporate Default Study and Rating Transitions publication,” writes Morningstar analyst Thomas Boccellari.
For more information on corporate debt, visit our corporate bonds category.
Max Chen contributed to this article. Tom Lydon’s clients own shares of HYG, JNK and LQD.