The Right Time to Use High Yield Bond Funds
In the current low-interest rate environment, high yield bond funds are staying true to their reputation and generating substantial interest income. Even after defaults, investors with these bonds in their portfolio are still earning above-market returns that are beating out investment grade.
High-yield bond funds are currently earning roughly four percentage points more than Treasuries. This makes high-yield bond funds an attractive option compared to the investment grade bonds. Even if high yield funds take some defaults, they can still produce yields more than three times the amount of investment grade bonds.
Income isn’t always the reason to consider high-yield bonds (although, it’s attractive). They tend to have a very low correlation with Treasuries—averaging .4. Bonds that are rated single-B have an even weaker tie to the Treasury market. Comparing this to an almost one-to-one correlation with investment-grade bonds and Treasuries, for example. This all being considered, high-yield bonds aren’t completely immune from interest-rate risks…and fully expect investors to pull back from this category once the Fed starts increasing interest rates.
This is where duration becomes crucial, and investment advisors may find it prudent to run a short duration high yield strategy—simply because it has significantly lower interest rate risk due to the short duration of the investment. In the current market, this may be the smartest way to participate in the high-yield space, as it manages downside interest rate risk and maintains an attractive yield profile.
CHOOSING FUNDS or ETFs, NOT INDIVIDUAL BONDS
Multisector bond funds and ETFs allow limited exposure to high-yield bonds. A dedicated high-yield bond funds provide an opportunity to move much like a stock fund. And the benefits of a multi-sector fund are plentiful, giving investors exposure to high-yield bonds, limits volatility in owning dedicated high-yield bond funds, and diversifies bond holdings.