High-Yield Bond Investing Not For the Faint of Heart
No pain, no gain. That's the mantra of the high-yield bond investor who is willing to assume the default risk of a bond if its yield and price seem worth the wager.
Relentlessly bad news and constant warnings about debt risk here and abroad, coupled with the recent extreme volatility of the junk bond market, mean even more courage is required in 2011.
Junk bonds remain a viable market for yield-seekers, but only for a small portion of an individual's portfolio. Anyone who believes the economy will worsen shouldn't consider them at all because debt of companies with subpar credit is not for the faint of heart.
The average high-yield bond mutual fund has a one-year total return of 13 percent and a three-year annualized total return of 10 percent, according to
Some experts see potential for a junk-bond rally based on recent investor overreaction, but that is not a sure thing. Although merger-and-acquisition financing has driven this year's market, some planned high-yield issues were pulled back, and investors continue to exit the market.
There are, however, good things to say about companies issuing high-yield bonds.
"In spite of all the bad macroeconomic news, when high-yield companies are viewed at the fundamental corporate level, things still look good," noted
Far more companies have gone from being junk issuers to investment grade than the other way around, Kessler said. The recession was very severe and default rates went up a lot, so companies that survived were those that "got religion" quickly, he believes. They made progress on the strength and liquidity of balance sheets.
The rating of bonds by credit-rating agencies, in descending order, is AAA, AA, A, BBB, BB, B, CCC, CC, C and D, with anything BB or worse generally considered a junk bond. Kessler believes investors interested in individual junk bonds should only seek out those in which the company could potentially be upgraded to investment grade or is significantly reducing its debt.
"While I personally don't love the high-yield bond sector right now, if the economy rebounds from its recent soft patch and shows improvement, it should do just fine," said
If a "really bad" recession unfolds, high-yield bonds "will get killed," Salzinger warned, because their yield won't be high enough to offer any kind of protection in a truly difficult period.
With that caveat in mind, Salzinger believes high-yield still has some worthwhile exchange-traded funds (ETFs, which trade on an exchange):
"For a portion of growth investors -- not just income investors -- high-yield bonds should represent a place to have money invested," said
Even though high-yield mutual funds remove some risk through diversification, Bold cautioned, investors should be fully aware that there will be more volatility than with other kinds of bond funds. That's why he believes junk should only be used for a small percentage of an individual's portfolio.
Again keeping risk in mind, Bold offers some high-yield bond mutual funds worthy of investor consideration:
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