Junk bonds have had better returns so far this year than many other income-generating assets have – even amid longer-term concerns about the health of the U.S. economy.
True, investors need to tread carefully in this part of the market. And junk bonds should be a small part of a portfolio for retail investors overall, if any.
Still, the $6 billion SPDR Bloomberg High Yield Bond ETF (ticker: JNK) had returned nearly 6% year to date through Thursday, including interest payments. That ETF is one way for retail investors to access this market.
That high-yield ETF’s performance compares favorably with minus 1% for the iShares Core US Aggregate Bond ETF (AGG), a proxy for investment-grade bonds.
High-yield bonds, issued by companies with credit ratings below investment grade, come with risk and reward.
The risk: the issuers of these bonds, at least in some cases, can go belly up, meaning the bond holders won’t get paid or get less than the full value. That risk increases when the economy worsens.
The reward: higher yields to entice investors in the first place.
For some perspective on these bonds, Income Matters Today tapped Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisors and a noted expert on this part of the bond market.
He warns that too many investors might be hearing the siren song of juicy junk bond yields.
“Yield-conscious investors are jumping into high yield -- and not paying too much attention to the risk premium (spread),” Fridson tells Income Matters Today. That’s “because after a long period of yields that couldn’t justify [investors] being in high yield, they can finally earn a big enough spread over their liabilities, or required actual returns, to make it worthwhile.”
Here are a few of his other thoughts:
The high-yield market rallied sharply in response to the Federal Reserve’s Nov. 1 announcement when it held short-term rates at current levels.
From Oct. 31 through Nov. 2, the effective yield on the ICE BofA US High Yield Index plunged from 9.38% to 8.93%. That 40-basis-point drop partly paralleled the drop in Treasury rates.
Remember that when a bond’s yield falls, its price goes up, and vice versa. So there was a rally for high-yield bonds over that period. That was the case for Treasuries, as well.
Investors have taken notice. High-yield funds saw inflows after eight straight weeks of outflows, according to BofA Global Research.
Marty Fridson
Fridson, however, points out that the risk premium – that is, the spread over corresponding Treasury yields – contracted by 27 basis points from 4.42 to 4.15 percentage points. A basis point is a hundredth of a percentage point. In other words, one basis point equals 0.01%.
Observes Fridson: “Investors took the Fed announcement [of no rate increase] as a signal that the Fed is at or close to ending the tightening, thereby lessening the probability of a recession.” That would be a good thing for these riskier bonds.
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