When constructing the fixed income component of portfolios, most individual investors and financial advisors focus primarily on debt issued by the U.S. government and high quality corporate debt. But the fixed income universe goes far beyond Treasuries and investment grade corporate bonds. Many investors have embraced junk bonds as quasi-hybrid investment, a bridge between equities and lower risk fixed income securities.

Junk bonds, also known as high yield bonds or speculative grade bonds, refer to debt issued by corporations that is rated below investment grade by major ratings agencies (i.e., S&P, Moody’s, and Fitch). Debt is given a speculative rating if there is deemed to be a higher risk of default or other negative credit events. In order to make these debt issues attractive to investors, junk bonds generally pay a higher yield than investment grade bonds.

Is there ever really a perfect middle ground on risk? Former “Junk Bond King,” Michale Milken, always wanted you to think so.

(Of course, Mr. Milken wound up with a 10-year sentence for securities fraud. And the SEC permanently barred him from the securities industry.)

We have been asking ourselves this question for the last couple of weeks and getting rather apprehensive in the process; we may have cool heads but we are still human!

From what we can see in the graphs below this clearly has not happened. The weakness we have seen over the last few days is nothing outside normal market volatility which is certainly not enough to suggest a change in trend.

That statement pretty much sums up the trends in place across the global financial market asset classes; equities, corporate bonds, and currencies.

1. World equity
2. Commodity
3. Precious metals
4. Corporate bonds
5. Currency - USD
6. Currency - High Yield

The strength is broad based and not just driven by a relative few stocks/commodities or sectors. Inter-market dynamics are largely supportive of the trends - by this we mean the strength in CRB was support by strength in both high yield currences and junk grade bonds.

By Matt Hougan

The basic premise of most corporate bond indexes is flawed. There has to be a better way.

It’s A Bird, It’s A Plane, It’s Superman! No wait…. it’s the loonie, a.k.a. the Canadian dollar. It’s closing in on parity with the U.S. dollar and by the looks of it, might blow past this psychologically important milestone before you finish reading this post.

What If Anything Is Gold Saying?

Despite a small setback in the stock market at the beginning of September and the short lived media frenzy of how September has been historically the worst month of the year for investors, the S&P500 returned a positive 3.57% in September 2009, extending the rally for the 7th consecutive month this year.

A previous post on bond ETFs elicited requests to explain why it is important to look at the yield-to-maturity instead of the yield quoted on financial portals like Yahoo Finance. Just why, for example, is it misleading to use Yahoo Finance’s quote of 4% on the iShares Canadian Short-Term Bond ETF [TSX:(XSB)] when iShares.ca’s website quotes the yield to maturity at 2.1%.

Exchange traded funds (ETFs) have many of the built-in advantages that mutual funds have, but there are also differences. In my view, the biggest difference is not the fact that ETFs trade throughout the day or even how ETF pricing works, but rather that ETFs have a very short operating history.

We use both mutual funds and ETFs so I am not at all negative about exchange traded funds, but I am aware that there will be growing pains as the ETF industry matures.

I frequently get asked by individual investors how they can earn more money on their cash. With interest rates of traditional savings vehicles such as money market accounts, money market mutual funds, and CDs all paying from 0.5% to 2% annually where should an investor look? My answer inevitably is that to earn significantly higher yields one needs to look beyond government insured deposit accounts and similar vehicles and consider corporate debt, foreign government debt, and municipal debt. While we hold LQD (investment grade corporate bond ETF), and HYG and JNK (high yield corporate bond ETFs) in many client accounts, I often buy municipal bond funds as a way to put uninvested cash to work.

The iShares National Municipal Bond ETF (MUB) is currently yielding 5.60% on a taxable equivalent basis (35% marginal tax rate – non-taxable yield is 3.64%) over three times the 1.71% average yield on 1 year CDs! If you are willing to endure even more risk, higher yields are available through leveraged closed-end muni bond funds. In the table below are 28 leveraged closed-end muni bond funds (1) with assets over $100M (2) that are all delivering taxable equivalent yields over 9% and (3) pay monthly dividends that (4) have been stable or increasing over the last 12 months and (5) trade at a discount to their net asset values (all data from www.cefconnect.com as of 10/8/09).

While most investors were mostly preoccupied by the strong rallies in the stock markets and ETFs, the bond market has enticed investors with high bond yields.

Standard & Poor’s commented that issuers are favoring the high-yield bond market over the leveraged loan market, with 86% of speculative-grade debt in bonds during the first nine months of the year compared to 45% in the same period last year, reports Tess Stynes for The Wall Street Journal.

Tuesday’s Wall St. Journal article on bond ETF pricing grabbed immediate front-page attention on Seeking Alpha, a righteous sign of these investments’ popularity and the site’s always-on radar systems.

Briefly, the WSJ article points out that popular corporate bond ETFs, including both the iShares short-term investment grade ETF (CSJ) and its long-term ETF (LQD), and the SPDR high-yield ETF (JNK) can trade at significant premiums to their underlying assets, as well as fall short of the returns of their respective indexes.

There was a wonderful article titled “Bond ETFs are Popular But Pricing Is a Problem”, written by Eleanor Laise, in the Wall Street Journal Tuesday. The article highlighted many of the shortcomings of bond ETFs, particularly the huge difference between the share price and the underlying Net Asset Value, but despite this phenomenon, investors are still demanding these investment vehicles.

Share prices of many bond ETFs are drifting far from the value of their underlying holdings, which can create big trading cost for investors. Some of the funds are straying from their benchmarks, meaning investors aren’t getting the returns they expected.

Junk (high yield) bonds are having their best year in history. At the start of 2009, risk averse was the popular theme in plunging stock markets. Junk bond prices plummeted sending their yields over 25%. Since early March, stocks roared back (popular stock averages are typically up 50%) and the rebound in junk bonds has been even more dramatic. Risk is being embraced and rewarded.

However, Treasuries rallied when risk averse behavior became the motivating force in the markets early in 2009. That rally cut the yield on the 10-year Treasury to only 2%. Then junk bonds rallied and Treasuries sold off sharply. The yield on the 10-year Treasury soared, touching 4% two months ago. In the last 2 months, Treasuries rallied again taking their yield back below 3¼%.

Over the past year, bonds and their ETFs have drawn much attention which have send the yields on these fixed income investment tools down.

According to Randall W. Forsyth of Barron’s, the rally has been specifically seen in the credit markets, in particular corporate securities as opposed to lower-risk Treasury securities.