Higher Yielding Bond ETFs: A 'Sweet Spot' on the Risk Spectrum

Includes: EMB, HYG, JNK, PCY, PHB
by: Gary Gordon

Cash yields 0% and 10-year treasuries yield 2.75%. The paltry returns make it likely that the money will flow somewhere else before too long.

Yet economic uncertainty has been scaring investors away from stock assets. Heck, if the cash-hoarding corporation won’t buy back more of its own shares because of a perceived need to self-finance in dangerous credit waters, why would others purchase the shares?

Again, though, investor dollars always look for a better home. And the preferred home these days is higher-yielding debt investments.

With Standard & Poor’s estimating that less than 3 percent of high-risk firms will default in June 2011, why wouldn’t an investor be interested in diversified ETFs like SPDR Capital High Yield Bond (NYSEARCA:JNK) or iShares High Yield Corporate Bond (NYSEARCA:HYG)? The 8%+ annual income that’s delivered monthly is 600 basis points better than treasury bond funds with comparable average maturities.

Granted, if the economic conditions improve significantly, and treasury bond yields rise, one may see the spread between treasuries and high yields narrow further. Or, if a double-dip recession were to hit, spreads could widen and high yield investing may go on temporary hiatus.

However, that’s where you come back to the likelihood that the actual percentage of defaulting corporations will be rather tame. At its worst point on a rolling 12-month basis, we witnessed 12/100 companies default, and the forecast is now 3/100. It follows that high yield corporate bond ETFs should remain attractive until there’s a healthy, self-sustaining economic recovery that compresses spreads to a mere 200-250 basis points.

The other area for yield seekers is emerging market bond debt. For example, the governments of emerging markets represent creditor nations, not debtor nations. Yet iShares JP Morgan Emerging Bond (NYSEARCA:EMB) and Powershares Emerging Market Debt (NYSEARCA:PCY) have distribution yields of 4.8% and 5.6% respectively. Ironically, these funds may be safer from default than developed world government bonds a la the sovereign debt crisis in Europe.

Approximate Year-Over-Year Gains For Higher Yielding Bond ETFs
Approx 1-Year %
PowerShares Emerging Sovereign Debt (PCY) 20.2%
iShares JP Morgan Emerging Bond (EMB) 18.8%
SPDR Capital High Yield Corporate (JNK) 18.2%
iShares High Yield Corporate Bond (HYG) 15.4%
PowerShares High Yield Corporate (NYSEARCA:PHB) 13.0%
S&P 500 SPDR Trust (NYSEARCA:SPY) 8.6%

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.