Quality Taking on Added Importance with Junk Bonds | ETF Trends

With yields on U.S. government debt depressed and likely to remain that way for several years, advisors are looking to other corners of the bond market to source income. Predictability, some will embrace high-yield corporate debt and the relevant exchange traded funds.

A safe avenue to the allure of junk bond yields is via model portfolios, including the WisdomTree’s Fixed Income Model Portfolio. The model portfolio features eight exchange traded funds, including one dedicated high-yield play.

“This model portfolio is focused on a diversified stream of income. It seeks to benefit from secular trends we see evolving in the fixed income markets in a risk-conscious manner. The model portfolio focuses on select opportunities in core sectors, while strategically allocating among sectors and extending the model portfolio’s reach globally,” according to WisdomTree.

Accessing Model Portfolio Quality

This model portfolio isn’t just about boosting yield. It offers advisors a way to increase fixed income quality in client portfolios. That’s a relevant consideration due to a recent increase in default rates in the high-yield space.

“While March seems like a long time ago (at least for me), the repercussions of perhaps the worst two-week period in the U.S. high-yield (HY) arena are now showing through some five to six months later. Interestingly, the news seems to have flown under the radar up to this point, but according to Moody’s, speculative-grade default rates in the U.S. have been increasing at a rather swift pace through the summer months,” said WisdomTree head of fixed income Kevin Flanagan in a recent note.

The model portfolio offers junk bond quality via the WisdomTree U.S. High Yield Corporate Bond Fund (CBOE: WFHY).

WFHY’s fundamentally-weighted methodology could serve income investors well if defaults increase. The fund tracks the WisdomTree U.S. High Yield Corporate Bond Index, which uses a multi-step fundamental screen to steer investors away from the junkiest of the junk bonds. That’s important at a time when many high-yield issuers are under scrutiny due to financing needs.

“We continue to believe there is relative value in the U.S. HY market, but as I mentioned, screening for quality is of paramount importance,” notes Flanagan. “The WisdomTree U.S. High Yield Corporate Bond Fund (WFHY) follows this approach by focusing solely on public issuers and eliminating those with negative cash flow. This strategy is designed to mitigate potential default risk, a key factor to consider given the expected HY backdrop in the months ahead.”

For more on how to implement model portfolios, visit our Model Portfolio Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.