The term "junk bond" does not mean what you might think. When we think of junk, we think of trash - something that, for most people, is useless. It ends up in a landfill never to be seen again. The recycling industry, along with many other companies, find ways to profit from junk. As an investor, you can too.
First, the term has fallen out of favor. More often, "high yield" is how investors characterize these bonds. Most aren't junk at all. In fact, many high-yield bonds are as safe as, or safer than, some of the more volatile stocks that pay a lower dividend, if any at all.
Still, high-yield bonds have more default risk than investment-grade bonds, and that's why using an exchanged traded fund (ETF) to gain exposure to this class of bonds might be the most responsible way to invest. There are numerous ETFs to use.
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The iShares High Yield Corporate Bond ETF (ARCA:HYG) holds more than 700 high-yielding bonds and has an expense ratio of 0.5%. Currently the ETF has a 12-month yield of over 6.5%. The fund is weighted heavily toward consumer services, financials and oil and gas issues, making it highly exposed to volatile sectors. With more than 735 bonds in the portfolio, the default risk is largely mitigated, however.
The SPDR Barclays High Yield Bond ETF (ARCA:JNK) is similar to HYG in that it has among its top holdings financials, telecoms and energy companies. The fund owns around 440 high-yield bonds and has an expense ratio of 0.4%.
The 0.1% difference in fees is significant. The fund's 52-week performance is nearly identical to HYGs, and its yield is nearly 6.72%. JNK might be the better choice based on metrics outside of the ETF's performance.
Another to consider is the SPDR Barclays Short Term High Yield Bond ETF (ARCA:SJNK). Closely related to JNK, this fund invests in high-yield bonds that will mature in less than five years. All of the bonds in the fund are U.S. dollar denominated, removing the currency risk for U.S. investors.
Does shorter maturity affect the performance? First, the expense ratio is 0.4% on this fund that holds about 350 bond issues. Its yield sits at 5.48%. Because SJNK is relatively new compared to JNK and HYG, investors should proceed with caution until it has a multi-year track record of success.
Similar to SJNK, the PIMCO 0-5 Year High Yield Corporate Bond (ARCA:HYS) seeks to capture the performance of the short-maturity, high-yield corporate bond market. Its 319 holdings come at a higher price - 0.55% - but it is currently yielding 4.43%. The fund has outperformed SJNK by about 2% over the past 52 weeks. In this case, the fund may pay back higher expenses with higher performance.
Because of Federal Reserve actions and other economic events, Bloomberg reported that junk bond funds received record inflows back in September. In one week, junk funds reported $3.63 billion in inflows. Junk Bond ETFs received 40% of it.
Facts like these have insiders wondering if a bond bubble has set up. If so, when will it pop, sending prices on these ETFs drastically lower? So far, that shows no sustained sign of taking place - leaving investors confident that their money is safe.
The Bottom Line
As with all market investments, always place two orders. Buy the ETF and then place a stop order to protect against any sudden moves to the downside. Bond ETFs have very low volatility, but placing a stop order is free protection.
As always, use these names as a way to begin researching the high-yield bond ETF market. Do not buy until you understand how these funds work.
At the time of writing, Tim Parker did not own any shares in any company mentioned in this article.