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The high yield bond market has been red hot, and the closed-end funds which specialize in this sector of the market have produced very attractive returns for investors over the last one and 3-year time frames. However, there are some warning signs that the high-yield bond market has become too overheated and the performance levels may start to lag.

My database traces 12 closed-end funds classified as high-yield bond funds. These funds invest in non-investment grade corporate bonds. Across the board, the funds use preferred share issues to leverage the portfolios with leverage in the 20% to 30% range. The funds are:

  • BlackRock Corporate High Yield Fund V, Inc (HYV)
  • BlackRock Corporate High Yield Fund VI, Inc. (HYT)
  • BlackRock Corporate High Yield Fund, Inc (COY)
  • BlackRock Corporation High Yield Fund III Inc (CYE)
  • Dreyfus High Yield Strategies Fund (DHF)
  • DWS Dreman Value Income Edge Fund, Inc. (DHG)
  • Neuberger Berman High Yield Strategies Fund Inc (NHS)
  • New America High Income Fund, Inc (HYB)
  • PIMCO High Income Fund (PHK)
  • Pioneer High Income Trust (PHT)
  • Wells Fargo Advantage Income Opportunities Fund (EAD)
  • Western Asset High Income Fund II Inc (HIX)

Group Average Results

Here is a round-up of the average returns of the high-yield funds. All returns are based on market share prices and historical results were derived from the Yahoo Finance adjusted share price data.

  • Currently, the average dividend yield is 8.6%.
  • The average total return for the last three years was 85.0%. As a group, the fund returns were consistent, ranging from a low total return of 67.8% to a high of 100.3%.
  • The average one year return was 23.2%. Eleven of the 12 funds returned between 21% and 29% - again very consistent. The laggard was the Dreyfus High Yield Strategies Fund which produced an anemic 3.2% total return.
  • The largest high-yield bond ETF - iBoxx $ High Yield Corporate Bond Fund (HYG) posted one and 3-year total returns of 12.7% and 42.5%.

The Dreyfus High Yield Strategies Fund was hit by a significant shrinkage of the price premium over the net asset value. On a NAV basis, the fund is up by 18% for the last year. Unfortunately the price premium is down from 22% to under 9% over the same time frame. Most of the premium collapse occurred since the distribution rate was cut from 4 cents a month to 3.5 cents two months ago.

Top Performing Funds

Near the top of both the one and 3-year return list is the DWS Dreman Value Income Edge Fund, Inc. DHG produced a 98% 3-year return for investors and was the top high yield fund with a 29% return for the last year. Also, this fund currently trades at just a 1.4% premium to NAV - definitely not the norm for this group of funds.

Other funds providing above average returns for both time periods include:

  • BlackRock Corporation High Yield Fund III Inc
  • BlackRock Corporate High Yield Fund V, Inc
  • BlackRock Corporate High Yield Fund VI, Inc.
  • Neuberger Berman High Yield Strategies Fund Inc

These four funds trade at reasonable - currently 5% to 7.5% - premiums to NAV. In contrast to these funds, two funds at the top of the three-year return list - Pioneer High Income Trust and the PIMCO High Income Fund are trading at premiums of 36% and 75% respectively. PHT and PHK were the numbers 1 and 3 funds on the 3-year return list. The share price premiums make them unattractive at the current time.

Premiums Bubbling Up

As I worked through the data for this article, I was struck by how much the share price premiums had expanded over the last 3 to 4 months. The typical high-yield, closed-end fund now trades at a premium 5% to 7% higher than the spread of just a quarter earlier. The PIMCO High Income Fund continues to defy belief, with the premium expanding from 63% to the current 75%.

The growing premiums on these high-yield funds is a good indicator to show the bubble nature of the high-yield bond market. The DWS Dreman Value Income Edge Fund, Inc. looks like the best value with its small premium. However DHG has historically traded at an 8% to 10% discount to NAV. I am currently inclined to stay clear of these closed-end funds until the premiums/discounts move closer to the historic averages.

Source: Top Performing High-Yield Bond Closed-End Funds