High-yield debt or “junk” bonds have gotten more attention from income-starved investors in recent years due to rock-bottom interest rates.
I believe high-yield bonds can play a supporting role in a diversified portfolio. In rising equity markets, junk bond prices can increase in value as the prospects for many issuers start to improve in my opinion.
High-yield bonds are issued by companies with debt ratings below investment grade. They pay higher yields to compensate investors for the extra risk.
In the Stable Equity portfolio, I recently added high yield debt exposure through the SPDR Barclays High Yield fund (JNK). This ETF currently holds debt issued by telecom players Sprint (S) and T-Mobile (TMUS).
Rising prices for junk-rated debt will cause the yield to lower eventually. However, the owner of the debt earns both the high yield during the price rise and a potential capital gain on the debt.
In a falling market, junk bond prices can fall almost as dramatically as the broad equity market. Yet a diversified junk bond portfolio will typically have a much higher yield than equities to help earn a return for the debt holder through the downturn.
JNK earned a place in the portfolio due to its solid yield and the fact that it offers some diversification benefit to the other equity and long bond positions in the portfolio such as the iShares 20+ Year Treasury Bond ETF (TLT). Diversification and yield made JNK an attractive addition to the portfolio.
DISCLAIMER: The investments discussed are held in client accounts as of August 31, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.