The first quarter of 2022 saw a massive pivot away from fixed income for many advisors and investors as the Fed embarked on its journey of quantitative tightening and fighting inflation through rising interest rates. Now, however, that trend is changing, particularly within high yield bonds as advisors look for income opportunities for portfolios in challenged times.
“There’s income back in fixed income,” said Kevin Flanagan, head of fixed income strategy at WisdomTree, on a recent call with VettaFi. Additionally, Flanagan explained that high yield bond funds are now being sleeved and utilized in “more traditional roles of being an income provider in a lot of portfolios.”
High yield bonds can carry a level of risk in an economic slowdown as the odds of default increase for companies when revenue decreases. Therefore, it’s vital that advisors and investors look under the hood of the funds they’re investing in to best understand the credit risk they are opening their portfolios to when investing.
The WisdomTree U.S. High Yield Corporate Bond Fund (WFHY) offers exposure to select U.S. non-investment-grade corporate bonds (also known as “junk bonds”) but utilizes a quality screen and rules-based approach to identify companies that exhibit strong fundamentals and then tilts to more heavily weight those companies that have favorable income characteristics.
“If you are concerned about a slowing economy, or even perhaps a recession, the quality screen actually is used to mitigate credit concerns and to help mitigate default-risk kind of issues,” explained Flanagan on the call.
Flanagan explained that defaults are a lagging indicator, as they come after economic slowdown, whereas WFHY tends to be forward-looking to predict default risk. The screen the fund utilizes filters out the lowest-liquidity securities and then seeks to identify default risk based on the probability of default for the bond compared to that of the other bonds within that sector. Issuers exposure is capped at a 2% representation within the fund.
In regards to quality, the fund invests in bonds with grades between BBB and CCC but is currently primarily invested in BB- (48.55% weight) and B-rated (34.66% weight) bonds.
WFHY invests broadly across sectors, with allocations in media (13.93%), healthcare (10.98%), energy (10.43%), industrials (9.46%), and many other sectors as of July 22, 2022.
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