Investors are facing growing interest-rate risk as Treasury bond yields hover near all-time lows. However, investors may find more lucrative and even safe options in high-yield corporate bond exchange traded funds.
Carl Kaufman, manager of the Osterweis Strategic Income fund, said he favors credit risk over interest-rate risk because interest-rate risk is higher at the moment, in an interview with Dan Culloton at Morningstar.
"I think that as we get further into this recession with low interest rates that the risk of rising interest rates becomes greater, whereas companies are flushed with cash, they are operationally about as efficient as they've been, and the fundamentals are actually quite good despite the weak macroeconomic backdrop," Kaufman said.
Consequently, the opportunities in high yield assets look much more attractive than investment-grade debt. However, yields have tapered down, especially on the long-end of the yield curve, so investors are no longer getting paid a large premium for the amount of risk they are taking. Kaufman, though, suggests focusing on short-term high-yields instead.
"We find the sweet spot to be one to three or four years. You're not giving up that much," Kaufman added. "Plus you have much more visibility one to three years out, than you do five to seven years out."
Still, investors should be aware that high-yield debt is tied to the well-being of corporate America. More recently, the high-yield debt and ETFs have experienced a major sell-off as the markets turned to a risk-off sentiment.
Companies, though, have been hoarding money after the 2008 crisis sent everyone into risk-averse mode. Consequently, American companies have been managing their cash conservatively.
"Credit risk in terms of the magnitude of credit risk right now is very low," Kaufman said. "The funding is freely available to them. The capital markets are wide open. They're refinancing their debt at decreasingly low rates."
Additionally, default has decreased dramatically as corporations refinanced their debt at lower rates.
"I think at this point, credit risk is at the low end of the historical spectrum," Kaufman added.
High-yield bond ETFs include:
- SPDR Barclays Capital High Yield Bond ETF (JNK)
- iShares iBoxx High Yield Fund (HYG)
- PowerShares High Yield Corporate (PHB)
- PIMCO 0-5 Year High Yield Corporate Bond (HYS)
Max Chen contributed to this article.
Disclosure: I am long HYG. Tom Lydon's clients own HYG.