As Junk Bond Defaults Rise, Mitigate Risks With These Options

A report by Schiff Gold noted that as interest rates remain elevated, corporate defaults have been on the rise. As such, investors may want to consider staying on the side of investment-grade debt until credit risks subside.

“Corporate bond defaults were up massively in 2023, especially for high-risk junk debt, and the trend is continuing this year at a pace not seen since the 2008 global financial crisis,” the report mentioned.

In the previous year, S&P Global Ratings noted that corporate bond defaults came in at an alarming rate of 80%. The start of 2024 has been met with record issuance as bond investors are looking to lock in higher yields now before rate cuts eventually take place.

Despite the defaults, the attractive yield is still drawing in bond investors, but for the more risk averse, there are investment-grade options to consider. That’s especially the case of more defaults occur in 2024 as the higher-for-longer interest rate narrative could continue if inflation keeps running hot.

“Demand remains strong for junk bonds and hybrid debt, but for companies with poor liquidity, poor to negative cash flow, and/or an outsized existing debt burden, the result is a compelling setup for even more defaults in 2024,” the report added.

Passive and Active Investment-Grade Exposure

Consider the diversified Vanguard Total Bond Market Index Fund ETF Shares (BND), which seeks to track the performance of the Bloomberg U.S. Aggregate Float Adjusted Index. That index represents a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States, including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities, all with maturities of more than one year. BND comes with a low expense ratio of 0.03%.

Active management is another option, and with the price of funds being more competitive versus passive funds, it’s a small price to pay given their added flexibility, especially in volatile markets. Given this, fixed income investors may want to consider active funds like the Vanguard Core Bond ETF (VCRB)., which comes with a low 0.10% expense ratio. As mentioned, active management helps maintain pliability, especially with a data-dependent Federal Reserve and interest rate policy moving markets as of late. Furthermore, holdings come under the auspices of experienced portfolio managers with the Vanguard Fixed Income Group.

Similar to BND, VCRB mitigates credit risk via diversified exposure to the U.S. investment-grade bond market. That doesn’t mean sticking strictly within the safe confines of U.S. Treasuries. Much like the diversification features of BND, the actively managed VCRB extends its exposure to other fixed income assets that include mortgage-backed securities and corporate securities. Again, with the active exposure that VCRB offers, investors are able to harness the inherent portfolio management capabilities.

For more news, information, and analysis, visit the Fixed Income Channel.