Back in the 1980s, high-yield bonds were known as junk bonds, since they were very likely to become worthless. Today these bonds are politely called "high-yield," but with recent turmoil in the markets, some may wonder whether they should still be called "junk." High-yield bonds are rated below investment grade, which should be a clue that there's a good chance they may default. Of course, the flip side is their potential for higher returns.
Rather than invest in one bond and risk having it becoming useless junk, investors should consider a high-yield fund with a diversified portfolio. In the ETF universe, iShares has the oddly named iBoxx $ High Yield Corporate Bond Fund (HYG). HYG tracks the iBoxx $ Liquid High Yield Index, a corporate bond market index compiled by the International Index Company. Since its inception this April, HYG has garnered nearly $110 million in assets.
HYG has fifty holdings, with the largest each accounting for roughly 2% of assets, including bonds from Goodyear (NYSE: GT ) , Dobson Communications (Nasdaq: DCEL ) , Freeport-McMoRan, (NYSE: FCX ) , Intelsat, and Hertz, (NYSE: HTZ ) . Sector exposure is highest in the media area, which makes up 13.7% of the fund's assets, while auto & parts make up 9.8%, and fixed-line telecom comes in at 7.8%.
HYG has an average weighted maturity and an effective duration of seven-and-a-third and five years, respectively, which means that its price and yield can swing more widely than a fund with shorter maturities and duration. At the same time, the fund's average weighted coupon is an attractive 8.08%.
The capital markets have been disrupted a bit lately by the subprime-mortgage mess, and that means more volatility and risk. The high-yield market has seen bond prices fall, but valuations were high prior to the subprime debacle, so this market might have been due for a breather anyway. There is also a strong argument that the high-yield market has run its course, and that returns going forward will not be as rich as they have been the last few years. One thing to keep an eye out for would be deterioration in the credit quality of high-grade bonds, which would indicate lowered future returns. All of this bad news might mean the high-yield market could soon be attractive.
HYG is not for investors who can't stomach a lot of uncertainty. Even for those who can assume some risk, high-yield bonds should only make up a small portion of your portfolio. With a 0.50% expense ratio, HYG gives investors relatively inexpensive access to a portfolio of high-yield bonds and the attractive yields available in this market.
Fool contributor Zoe Van Schyndel lives in Miami and enjoys the sunshine and variety of the Magic City. She owns shares of SDS, but does not own any of the other funds or securities mentioned in this article. The Motley Fool has a disclosure policy.
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