As the Fed has kept interest rates at persistently low levels, investors have shown a penchant for anything that kicks off a high dividend. Master limited partnerships (MLPs), real estate and dividend paying stock funds- like the Guggenheim S&P Global Dividend Opportunity ETF (NYSE: LVL) -have become portfolio necessities as investors try to navigate these uncharted waters.

That is, until the Federal Reserve began their tapering stance.

Since then, a variety of high yield sectors have sold off as the Fed begins winding down its bond purchases. Surprisingly resilient to the taper has been high yield or junk bonds. The sector surged in 2013 and more gains could be ahead for investors.

Bullish Tailwinds

Despite returning 8% last year, the high yield bond sector may be a great place for investors to place their money in 2014. A variety of analysts predict the sector could see similar total returns for the full year. The reason: better global economic data. Companies that issue junk bonds have spotty credit scores and their returns are highly correlated with economic health rather than the level of interest rates.

According to analysts at Invesco, the high yield sector has only had negative returns four times since 1980. Each of those periods of loses were associated with a recession. As economic growth in the U.S. continues to move ahead, forecasts for GDP increases in 2014 are within the 2 to 2.5% range. Invesco’s data shows that this amount of GDP growth is usually highly supportive of junk bond returns. Globally, analysts are predicting similar GDP gains- 2.84 % this year and 3.07% in 2015.

Aside from strong economic growth propelling junk bonds, there are a few other bullish catalysts as well.

Perhaps the biggest is that defaults rates are still below historic averages. A recent report from Moody’s shows that junk bonds' default rate for the fourth quarter of 2013 fell to just 2.2%. That’s down from 2.7% in the previous quarter and 3.4% a year earlier. The junk bond default rate reached a high of 13.4% in the third quarter of 2009. That rate should remain low as most of the new issuance has helped dramatically lower near-term maturities. Additionally, earnings for junk bond issuers have been rising faster than debt levels in the fourth quarter.

Finally, the supply of new junk bonds is slowing. Last year set a record in nearly $400 billion worth of new high-yield bonds. Analysts now predict that 2014 will see a 15% decline from that amount. That lends itself to higher prices.

Adding Some Exposure

Given the generally supportive market for junk bonds, investors may want to add some high-yield exposure. The biggest exchange traded fund (ETF) in the sector is the $13 billion iShares iBoxx $ High Yield Corporate Bond (NYSE: HYG). The ETF tracks 900 different junk bonds from issuers like Sprint (NYSE: S) and Springleaf Financial (NASDAQ: LEAF). Average credit quality for the fund is in the upper tier of the junk bond ratings scale. This produces a hefty 5.68% yield. For a slightly more concentrated and higher yield fund, the SPDR Barclays High Yield Bond (NYSE: JNK) could also be used.

Another option could be bank loan funds. These bonds usually have coupons that rise when interest rates do and reset every 30 to 90 days. Perhaps more importantly, the S&P/LSTA U.S. Leveraged Loan 100 Index- the main benchmark of these bonds- increased for the first time since October of 2012 when the floating rate debt level advanced despite a monthly drop in the S&P 500 index.

That means investors may be shifting from stocks to loans for yield and safety. The PowerShares Senior Loan Portfolio (NAASDAQ: BKLN) tracks the benchmark index and currently yields 4.26%. That yield should increase as interest rates rise. Another option is the actively managed SPDR Blackstone/GSO Senior Loan ETF (NASDAQ: SRLN). This ETF uses screens to find the “best” bank loans and yields 2.14%.

Finally, investors may want to broaden their search and head overseas for high yield bets. International junk bonds have fallen by the wayside as investors have shunned risk. Yet, many of these firms are just a stable as U.S. junk bond issuers. The Market Vectors International High Yield Bond ETF (NYSE: IHY) can be used to bet on developed market issuers, while the iShares Emerging Markets High Yield Bond (NASDAQ: EMHY) can be used to add a swath of emerging market junk bonds. The ETFs yield 6.39% and 6.16%, respectively.

The Bottom Line

For those investors looking for a good balance of risk and reward, high yield bonds could be a great play this year. There’s plenty of bullish catalysts that should propel junk bonds ahead.

Disclosure: The author has investments in the iShares Emerging Markets High Yield Bond.

Related Articles
  1. Technical Indicators

    Strategic Beta ETFs

    Strategic Beta ETFs By Greg McFarlane As the financial markets get more sophisticated and arcane with time, the number of different types of investment scheme proliferates. It was only a few ...
  2. Mutual Funds & ETFs

    Bond ETFs: A Viable Alternative

    Discover the advantages of a security that tracks bond index funds, but trades like a stock.
  3. Options & Futures

    An Introduction To Corporate Bond ETFs

    Learn about the pros and cons of these specialized ETFs, and get in on the opportunities they can provide.
  4. Mutual Funds & ETFs

    Fatal Seduction Of The Municipal Bond Insurers

    Learn how a foray into CDOs and other exotic products ruined an industry's image.
  5. Chart Advisor

    3 Ways to Trade the Rising Volatility

    With volatility increasing in the markets, many are turning to these three volatility-capturing exchange-traded products.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares US Basic Materials

    Learn about the iShares US Basic Materials exchange-traded fund, which invests in the equities of chemicals, metals and industrial gas companies.
  7. Mutual Funds & ETFs

    ETF Analysis: Ultra Oil & Gas

    Find out more about the ProShares Ultra Oil & Gas exchange-traded fund, the characteristics of the ETF and the suitability and recommendations for the fund.
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
  9. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  10. Mutual Funds & ETFs

    Comparing ETFs Vs. Mutual Funds For Tax Efficiency

    Explore a comparison of mutual funds and exchange-traded funds, or ETFs, and learn what makes ETFs a significantly more tax-efficient investment.
  1. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  2. Debt/Equity Ratio

    1. A debt ratio used to measure a company's financial leverage. ...
  3. Long-Term Debt

    Long-term debt consists of loans and financial obligations lasting ...
  4. Revenue-based Financing

    Revenue-based financing, also known as royalty based financing, ...
  5. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  6. Freelance Economy

    A freelance economy revolves around hiring self-employed workers ...
  1. What is the formula for calculating weighted average cost of capital (WACC) in Excel?

    When analyzing different financing options, companies need to look at how much it will cost to fund operations. There are ... Read Full Answer >>
  2. Why can additional paid in capital never have a negative balance?

    The additional paid-in capital figure on a company's balance sheet can never be negative because companies do not pay investors ... Read Full Answer >>
  3. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  4. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!