In a bull market and rising interest rate environment, high-yield, or "junk," bond investors could begin thinking about switching over to stock exchange traded funds.
Mike Roberge, chief investment officer at MFS Investment Management, argues that stock returns could begin to outpace high-yield bonds, reports Jason Kephart for InvestmentNews.
Anxious bond investors typically look at default risk in junk bonds, especially in a downturn. However, given the current price on bonds and their historically low yields, Roberge is less concerned about credit risk and points to interest rate risk.
"High yield is totally dependent on the [Federal Reserve] to get a higher return than the coupon," Roberge said in the article. "High-yield rates have fallen so low that you now have interest rate risk. Historically that hasn't been the case. There used to be a cushion."
The Barclays U.S. Corporate High Yield Index now provides an average yield of about 5.73%. Before the plunge in benchmark rates and the rally in bonds, speculative grade debt investors enjoyed double-digit yields.
"You're paying par or a premium for a market that has no upside, that still has economic risk and now has interest rate risk," Roberge added. "We're not anti-fixed income, but if you want to take economic risk right now, we prefer equities. They have more upside and offer better inflation protection."
So far this year, iShares iBoxx High Yield Corporate Bond (HYG) has added 5% and SPDR Barclays High Yield Bond (JNK) is up 4.5%. Moreover, HYG has a 5.04% 30-day SEC yield, and JNK shows a 5.37% 30-day SEC yield.
Max Chen contributed to this article.
Full disclosure: Tom Lydon's clients own HYG, JNK, SPY and QQQ.