Sometimes the name says it all. Junk bonds, for example, advertise truthfully what they are selling. The ETF we are looking at also has almost the same word as its stock symbol. The SPDR Bloomberg Barclays High Yield Bond ETF (NYSEARCA:JNK) is the one we will be examining today and telling you why this is just too risky for us.
JNK carries almost $8.0 billion of assets and is a rather large fund in today's market filled with multiple tiny ETFs. JNK tracks the Bloomberg Barclays High Yield Very Liquid Index and seeks to provide investment results that aim to replicate those. Some key features here include:
JNK has less than 1% (0.57% to be exact) in bonds rated BBB or higher. About half the holdings are in BB rated bonds and a stunning 12.07% in CCC rated bonds.
While it may be easy to blame JNK for reaching for the junkiest of the junk, this is pretty much what the index is made up of today as you can see with the Index Quality breakdown.
The fund aims to hold bonds that have a remaining maturity of between 1 and 15 years. This shows up in the current weighted average maturity of 6.26 years. Investors must note that over a third of its bonds have maturity rates of well past 7 years.
The fund is extremely well diversified though, with 1255 different holdings on last check with top 10 holdings making up about 3% of the total.
The fund has a stated yield of about 4.4% on most investment websites and that comes from the trailing distributions.
Source: Seeking Alpha
The last distribution of 39 cents creates an annualized yield of 4.3%. Unfortunately, the actual yield for holders as of today is far lower and the 30 Day SEC yield which computes this comes to just 3.79%.
At a 3.79% yield, investors are taking on some extraordinary levels of risk for a small return. Keep in mind here that there are lots of junk bonds maturity out 10 years or more and that timeframe will likely have quite a few defaults and restructurings. In this case, the credit risk is what is rather lopsided in relation to the yield. The fund does have some modest duration risk but that is an acceptable amount if you want to have bonds in your portfolio. Of course, if you get the dual hit from duration and credit at the same time, the fund could easily lose 15-20% in a single year, creating a rather big reach for a 3.79% yield. Here we are talking about just a garden variety reset. If we have something bigger like a contagion from China, where high yield bonds yield chart looks like some of our technology bubble charts, then you might have an even more turbulent time.
While bond yields on junk don't remotely compensate you for the risks, investors can consider making money by placing bids to buy high quality companies at the right price. Currently the REIT sector has some attractive valuations and when you combine that information with selective placement of bids, you get far better risk-adjusted income in our view. For example, W.P. Carey (WPC), one of the best REITs in our view, trades at a forward multiple of 17X and at about a 15% premium to tangible NAV. Unlike the pure bubble valuations of REITs like Safehold (SAFE), it also yields 5.5%. But investors got a chance to make an even higher annualized yield recently by selling the $70 Cash Secured Puts.
Source: Interactive Brokers Sep 24, 2021
Source: Author's App
The dual advantage here is if WPC never goes under $70 you make a 9.68% annualized yield which is far higher than you get with JNK. If the stock gets put to you, your effective cost basis is $66.45, which we want to point out is right near its NAV. That also gets you a 6.3% yield on your net entry price. To us, bidding for high quality equities at the right price, beats blindly buying an index of junk bonds for just a fraction of the yield.
Income investing continues to require prudence. Even though we generated over 15% income in the last 12 months in our Cash Secured Put Portfolio, we think this year it will be significantly less. JNK on the other hand is a hard pass for us. Don't get us wrong though. We have recently taken up positions in bonds where we can get 5% plus with less than 18 months to maturity. It was also a company that had recently raised its dividends. So we will pick our spot if the setup is right. But passive high yield ETFs are on our naughty list for this Christmas.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
Conservative Income Portfolio targets the best value stocks with the highest margins of safety. The volatility of these investments is further lowered using the best priced options. Our Cash Secured Put Portfolio generated over 15% income in the last 12 months. We focus on being the house and take the opposite side of the gambler.
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Conservative Income Portfolio is designed for investors who want reliable income with the lowest volatility.
High Valuations have distorted the investing landscape and investors are poised for exceptionally low forward returns. Using cash secured puts and covered calls to harvest income off value income stocks is the best way forward. We "lock-in" high yields when volatility is high and capture multiple years of dividends in advance to reach the goal of producing 7-9% yields with the lowest volatility.
Preferred Stock Trader is Comanager of Conservative Income Portfolio and shares research and resources with author. He manages our fixed income side looking for opportunistic investments with 12% plus potential returns.
Disclosure: I/we have a beneficial long position in the shares of WPC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.