How to Invest in Junk Bonds

February 8, 2012 · 2 comments

Investors have been flocking to junk bonds and their brethren, more conveniently named “High Yield ETFs”.  This isn’t entirely illogical given the near zero interest rate policy from the Fed, blue chip dividend yields dropping as shares appreciate, and 2-3% yields on long-term US treasuries.  Junk bonds are classically the corporate debt from B- rate companies and lower.  According to Dealogic, last week set a new record for junk bond offerings, at $20Billion for the week.  This broke the record from last year in May.

How to Invest in Junk Bonds

Rather than sorting through individual corporates, the best approach for most retail investors would probably be the various high yield ETFs.  These include SPDR Barclays High Yield (JNK) and iShares iBoxx High Yield (HYG). Year to date, the ETFs have returned 3% and 2%, respectively and the yields are 6.9% and 7.5% respectively.  While these yields are nothing to sneeze at, they’ve come down considerably given the strong returns since the financial crash.  Evidently, without attractive alternatives out there at this yield, investors feel confident enough in the economy that we aren’t going to have a rash of bankruptcies to plow billions of dollars weekly into the junk market.

Other Developments in Bond Alternatives

Municipal bonds have been the stalwart for high net worth investors looking for triple tax-free returns, but the yields are down near 3% or so for highly rated issues.  Meantime, some municipalities are continuing to struggle, but nothing like Meridith Whitney’s ill-fated call that the US would see Billions of dollars in municipal defaults by now.  Elsewhere in Treasuries, Bernanke recently announced that there would be no rate increases through 2014, further suppressing bond yields on all maturities.  To achieve decent yields outside the junk space, but outside the US as well, consider these International Bond ETFs.

Perspective

If you believe in efficient markets, then, there’s never really a “deal” out there for investors.  Basically, yes, you’re receiving a considerably higher yield in junk bonds and their ETF equivalents, but you should expect the volatility and risk of loss commensurate with that higher current yield.  Personally, I like holding high yield ETFs like this in my self-directed IRA portfolio so I can derive dividend income tax-free and keep growing the account by reinvesting the dividends.  Occasionally, I also like to sell puts and calls for option income. If you’re thinking of getting into options investing, here are optionsxpress promotions.  For disclosure, I own HYG in my self-directed IRA.

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AAAMP Blog February 8, 2012 at 2:01 pm

I agree that ETFs are the best, and really the only, way individual investors should be investing in junk bonds. Holding a variety of bonds (diversification) is paramount when dealing with high risk investments.
However I would caution investors who are looking for yield that we are in a long term deflationary cycle. Reagardless of whether the Federal Reserve is able to reinflate or not; these bonds could have very high default rates. Personally I don’t think the yields compensate for the risk taken in the current enviornment.
Ken Faulkennberry

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