Two Bond Funds for High-Yielding Debt
There is no doubt that the investing environment we have had to cope with over the past few months has been far from ideal.
With ample amounts of uncertainty pestering the markets, many investors have opted for the safety and security that comes with owning bonds.
Now, as a money manager focused on growing and preserving the wealth of my clients for the long term, I believe that fixed income is an essential element of any well diversified portfolio. However, there are a number of different ways to play the bond market which can appeal to different types of investors.
For instance, the most conservative type of investors may desire holdings comprised of U.S. Treasuries. Generally considered risk-free, there is near zero chance that the government-issued debt underlying funds such as the iShares Barclays 20+ Year Treasury Bond Fund (TLT) will be defaulted on. This type of security, however, does not come without sacrifice. In this case, it comes in the form of lower yield. TLT currently pays out 3.75%.
While stable, a fund like TLT may not sit well with risk tolerant investors who are seeking larger returns.
For this type of investor, I suggest going with an ETF or mutual fund designed to track the high-yielding debt markets.
For a long while I have used products such as the iShares $ iBoxx High Yield Corporate Debt Bond Fund (HYG) and the Federated High-Income Bond Fund (FHIIX) to tap into below investment grade corporate debt. Whereas TLT yields less than 4%, HYG and FHIIX pay out approximately 9% and 8% respectively.
HYG tracks a passive index comprised of over 350 U.S. dollar-denominated corporate debt securities rated below investment grade.
Similar to HYG, FHIIX tracks a diverse basket of below-investment grade bonds. Unlike the ETF option, FHIIX is actively managed, with a 35% turnover.
Being an actively managed mutual fund, FHIIX carries a higher expense ratio than HYG. However, throughout 2010, having a manager has paid off, resulting in the mutual fund’s outperformance versus its ETF competitor.
Like TLT, gaining exposure to the higher yielding bonds underlying HYG and FHIIX requires a tradeoff. In this case, investors are forced to give up some safety. Companies whose debt is considered below investment grade are typically viewed as more prone to default. While for some, this may raise red flags, I am not overly fearful. Rather, I see corporate debt as a promising endeavor.
As evidenced by this most recent earnings season, corporations are befitting from factors including strong balance sheets and rising profits. Additionally, despite the general concerns regarding the broad economic picture defaults have largely been absent. Looking ahead, I am confident that these factors will keep corporate bonds buoyed into the foreseeable future.
HYG and FHIIX appeal to different types of investors. However, in the end they both represent a popular destination for those seeking a balance of protection and payoff in today’s tricky market conditions.
