The search for income yielding stocks and exchange traded funds has become commonplace these days and made dividend and high-yield bond ETFs very popular.
"Those considering high yield as a replacement for another fixed-income sector should exercise caution with new investments right now. The current economic situation is very uncertain and any further economic weakness will surely cause prices to fall. On the other hand, for investors considering high-yield bonds as an alternative to U.S. stocks, the current yield looks more attractive," John Gabriel wrote in a recent Morningstar article.
Corporate bonds are called "high yield" for the sole reason that the firms issuing them are highly leveraged. With increased leverage comes the increased probability of default and bankruptcy. Subsequently, risk equals return, and the "high" yield of these bonds is designed to compensate investors for this risk.
Over recessionary periods, it is more likely that high-yield bonds will retain their value better then U.S. stocks, and you'll be receiving the high current yield. Furthermore, as the economy improves, credit spreads tighten causing high-yield prices to rise, which will give an investor a capital gain and the current yield.
Billions of dollars have flowed into the junk bond sector. In fact, the Barclays Capital High Yield Bond Index Posted a 58.2% gain in 2009, and over the past 3 years the index has given back an annualized 19.7%, reports Amanda Tyler for The Motley Fool.
Some high-yield bond ETFs:
- SPDR Barclays Capital High Yield Bond ETF (JNK) yields 7.3%
- iShares iBoxx High Yield Corporate Bond Fund (HYG) yields 7.3%
- Market Vectors High Yield Muni ETF (HYD) yields 5.4%
- iShares Global High Yield Corporate Bond ETF (IHY)
Tisha Guerrero contributed to this article.
Additional disclosure: Tom Lydon's clients own HYD and HYG.