High-yield bonds: Buy the dip
Junk bond prices have tumbled amid the oil-price plummet, stock market volatility and concern about rising interest rates. The Barclays U.S. Corporate High-Yield index has produced a return of -2.8% in the past year. And the index's yield has risen to about 7.6%, compared with about 1.7% for the Barclays U.S. Treasury index yield.
"Yield spreads have widened to the point where lenders are reluctant to extend credit to lower-rated borrowers," says Jack Ablin, chief investment officer for BMO Private Bank. "But it's not a distressed asset class. The default rate is quite low." The default rate for high-yield bonds totaled 2.5% through September.
Yields at these levels are quite attractive compared with other income-producing assets, he adds. "We would use the near-term turbulence as a more attractive entry point."
Tom Fredrickson, an independent financial adviser in New York City, also sees the high-yield space as appealing. "It might be a reasonable strategy to allocate a sliver of one's portfolio to a low-expense, no-load high-yield fund, such as Vanguard High-Yield Corporate," he says. The fund has an expense ratio of 0.23% and yields 5.6%.
But bear in mind that these are bonds of companies with below-investment-grade credit ratings. "They are far riskier than plain vanilla bonds and should not substitute for those bonds," Fredrickson says.