Equity markets have gotten off to a solid start in the new year, although looming eurozone debt woes continue to breed some degree of pessimism and one piece of bad news from overseas is very well capable of sparking a broad sell-off that spills over onto Wall Street. The tug of war between positive economic data releases on the home front and turmoil in Europe continues, paving the way for volatile trading across asset classes as investors struggle to decipher which way the markets will tip next. Amidst the ongoing uncertainty, many investors are gravitating toward dividend-paying securities, particularly in the fixed income corner of the market, in an effort to favorably position themselves as the global financial drama develops in 2012.
High yield bonds, commonly refereed to as “junk bonds," have taken on great appeal among investors looking to beef up their portfolios’ current return and further diversify their bond component. With government debt woes still plaguing confidence in the markets and expectations for interest rates to remain low in the foreseeable future, it’s not much of a surprise to see investors opting for dividend-paying securities in the bond space in lieu of chasing after lucrative stock market returns.
High Hopes For “Junk” Debt
Despite the rather unappealing “junk bond” label, high yield corporate debt may be one of the few bright spots in 2012 for those looking to enhance their current return without taking on considerable risk. While U.S. Treasuries are undoubtedly one of the “safest” segments of the bond market, their rock-bottom yields leave much to be desired. Furthermore, government bonds may come under pressure over the coming year if economic conditions at home continue to improve, which would in turn prompt investors to reallocate capital to more attractive corners of the market.
The high yield bond segment is stacked with opportunities in 2012 as this corner of the bond market offers attractive upside potential, while also generating an appealing current return for investors willing to step into the space. Investing in this corner of the fixed income market may appeal to investors for a variety of reasons. First and foremost, the underlying fundamentals of this asset class suggest that the inherent risks are significantly fewer than many might expect. According to Fitch Ratings, the default rate for U.S. companies in the high yield universe is expected to be around 2.5-3%, well below the historical long-term average annual rate of 5.1%. Relatively lower rates of default translates into a more attractive risk/return profile for junk bond investors.
Another compelling piece of evidence from JPMorgan is the fact that high yield issuers are becoming more and more profitable, and leverage in the space has been broadly, and steadily decreasing since peaking in late 2009. Additionally, improving economic conditions coupled with robust corporate earnings (and record levels of cash on hand) are two key factors that may further reduce the risks associated with high yield debt notes. Compelling fundamental improvements in the junk bond space make this corner of the market difficult to ignore given the juicy dividends that are sure to impress even the most yield-hungry investors.
Below we highlight five intriguing funds from the High Yield ETFdb Category that may perform well in 2012:
- iShares iBoxx High Yield Corporate Bond Fund (HYG): This is the biggest offering in the space with nearly $11.7 billion in assets under management. HYG holds over 450 high yield, U.S. dollar-denominated corporate debt notes and had a recent 30-day SEC yield of 7.23%. This ETF is well diversified from a sector perspective and is also available commission free to Fidelity account holders (see HYG Fact Sheet).
- SPDR Barclays Capital High Yield Bond ETF (JNK): This ETF features similar exposure to HYG, although it offers a bit less in the way of diversity. JNK’s underlying portfolio consists of roughly 220 holdings and is tilted toward debt notes from companies in the industrial sector (see JNK holdings). This ETF had a recent 30-day SEC yield of 7.41% and is also available commission free to TD Ameritrade account holders.
- PowerShares High Yield Corporate Bond Portfolio (PHB): This ETF separates itself from traditional “junk bond” ETFs by employing a fundamental approach that assigns weights to individual debt holdings based on four factors: Book value of assets, gross sales, gross dividends, and cash flow. PHB charges a competitive 0.50% expense ratio and had a recent 30-day SEC yield of 5.47%.
- PIMCO 0-5 Year U.S. High Yield Corporate Bond Index Fund (HYS): This fund tracks the BofA Merrill Lynch 0-5 Year US High Yield Constrained Index, which consists of 150 U.S. dollar denominated corporate debt securities rated below investment grade with remaining maturities of less than five years. HYS has a recent 30-day SEC yield of 7.16%.
- Guggenheim BulletShares 2012 High Yield Corporate Bond ETF (BSJC): This bond ETF is unlike the majority of fixed income products as it tracks an index designed to represent the performance of a held-to-maturity portfolio of U.S. dollar-denominated high yield corporate bonds with effective maturities in 2012. BSJC has little in the way of interest rate risk and should bear relatively low credit risk as well seeing as how the principal amounts of the underlying notes will be repaid during the current calender year. This one-of-a-kind bond ETF has a recent 30-day SEC yield of 4.94% (see BSJC Fact Sheet).
Disclosure: No positions at time of writing.
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