"Junk bonds" - the term still brings to mind Michael Milken and Drexel Burnham Lambert…
But these days, junk bonds are more often referred to as "high yield."
And while junk is still junk by any other name, under the heading "high-yield bonds," there are really two different kinds of investments.
One, there are the bonds issued as plain old junk (i.e. - by companies with horrible credit ratings).
And, two, bonds issued as investment grade (i.e. - by companies that fell on hard times and, in the process, saw their good credit erode).
The latter are sometimes referred to as "fallen angels." And finding the right ones can provide solid cash flow and profit potential.
Let's take a look at an index based on these once-well regarded bonds and one fund that tracks it…
Bigger, Better Junk
The index is called the Bank of America Merrill Lynch US Fallen Angel High Yield Index, and it consists of below-investment grade U.S. corporate bonds rated investment grade at the time of issuance.
The ETF that tracks this index is the Market Vectors Fallen Angel High Yield ETF (NYSEARCA:ANGL).
Part of the lure of so-called fallen angels is that such bonds, which were once investment grade, are often the bonds of larger, more established companies.
So although the issuing companies tend to be suffering from a ratings decline, many of them are still in better shape than the companies that had to issue junk as junk in the first place.
Further, those companies that have lost their investment grade credit rating typically want to repair it and are working toward getting that good credit rating back.
And, not unlike stocks, when a fallen angel company fixes its credit problems and receives a restored rating, the value of the bonds tends to rise, providing investors with an opportunity for profit on top of the high income.
The Fallen Angel Portfolio
Looking through the holdings of ANGL, there are a number of big name companies that have certainly seen better days…
You're not likely to read much about these stocks at our site simply because neither J.C. Penney nor Sprint pay dividends, and U.S. Steel has a negligible yield of 1%.
Nevertheless, all have issued bonds with high yields, and actively contribute to the yield and success of ANGL.
Case in point: ANGL has a yield of 6.16%, which compares well to other high-yield funds, like the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG) with its yield of 6.32%.
Granted, HYG's yield is a bit higher, but ANGL benefits from lower volatility - and it should, if it's executing the fallen angel concept effectively.
And despite the fact that ANGL has only been around for a little more than a year, it's still managed to significantly outperform HYG during that time.
For the period ending June 30, 2013, HYG was up 7.61% versus ANGL, which was up 11.64% over the same period.
Bottom line: High yields are tough to achieve. Especially when safety is a factor. But given the relative maturity and stability of most fallen angel companies, income seekers have far less to worry about than with regular, run-of-the-mill, high-yield bonds. And by applying the strategy via a fund like ANGL, that risk is mitigated even further.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.