The fixed-income universe offers investors numerous ways to slice and dice their portfolio. For those looking for maximum safety, U.S.-government-issued Treasury bonds with a short maturity offer a combination of virtually zero default risk along with low interest rate sensitivity.
“The bond that you’re buying represents the creditworthiness of whomever you’re lending that money to,” says Michael Wagner, co-founder and chief operating officer at Omnia Family Wealth. “For example, the U.S. government would be very creditworthy and come with relatively low risk, but also low return.”
On the other hand, investors willing to take on more credit risk hunting for higher yield potential can consider investment-grade corporate bonds, which are issued by companies to finance their various operational and growth needs. But what about for those seeking even higher income?
The solution here is high-yield bonds, also referred to as “junk” bonds. “A high-yield bond is a corporate bond with credit ratings below BBB from two out of three recognized credit-rating agencies such as Moody’s, S&P and Fitch,” says Evan Mann, senior high-yield analyst at Gimme Credit, an independent corporate bond research firm.
High-yield bonds therefore sit at the more extreme end of the fixed-income universe’s risk-return spectrum. “The benefits for high-yield bonds are they pay a higher level of interest income than does an investment-grade or Treasury bond, while the biggest risk is credit risk in the form of a possible default that leads to a loss of principal,” Mann says.
Wagner agrees, noting: “A high-yield bond is like making a loan to a company that might have more risk – the risk that you’re not going to be paid back at all.” In the event of a default, investors may lose not only their promised interest payments, but also their principal investment.
Therefore, investors who purchase high-yield bonds must come to terms with the possibility of a complete loss should the issuing company default on its debt. The high yield paid by the bond is no free lunch — rather, it merely compensates investors for taking on much greater credit risk. To mitigate this risk, the age-old practice of diversification may be appropriate.
“Given that high-yield bonds carry a much higher level of credit risk than investment-grade bonds, diversification is very important,” Mann says. “Investing through a mutual fund or exchange-traded fund can provide that level of diversification.”
By buying a fund that holds hundreds, if not thousands, of high-yield bonds of different credit qualities, issuers and maturities, an investor can better spread out risk. While the fund can still lose value, the chances of a complete wipeout compared to a single high-yield bond is much lower.
“I think retail investors should generally access high-yield bonds through a pooled investment vehicle like a mutual fund or ETF,” Wagner says. “It’s very difficult for a regular retail investor to analyze the high-yield bond market, and you really have to do a lot of due diligence and credit-risk analysis on these companies as if you were a bank making a loan to them.”
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Here’s a look at seven of the best high-yield bond mutual funds and ETFs on the market right now:
| Bond Fund | Yield to maturity |
| iShares 0-5 Year High Yield Corporate Bond ETF (ticker: SHYG) | 8.4% |
| SPDR Bloomberg High Yield Bond ETF (JNK) | 9.3% |
| Northern Trust High Yield Fixed Income (NHFIX) | 9.6% |
| iShares Fallen Angels USD Bond ETF (FALN) | 7.8% |
| iShares High Yield Corporate Bond BuyWrite Strategy ETF (HYGW) | 8.4% |
| Vanguard High-Yield Corporate Fund Investor Shares (VWEHX) | 6.9% |
| Invesco Senior Loan ETF (BKLN) | 9.7% |
iShares 0-5 Year High Yield Corporate Bond ETF (SHYG)
“We’ve found SHYG to be a compelling holding,” says Christopher Manske, president at Manske Wealth Management.”For example, according to Morningstar, it’s largest decline ever has only been 8.8% and that happened from January 2022 through June 2022.” Manske notes that a “much-overlooked metric” for selecting high-yield ETFs is volatility, as measured by a fund’s maximum drawdown.
Currently, SHYG is paying an average yield to maturity of 8.4%, which is the theoretical return an investor will receive if all of the ETF’s underlying bonds are held to maturity. Alongside this is a low average duration of just 2.4 years, a measure of interest rate sensitivity. Should interest rates rise by 1 percentage point, SHYG can be expected to lose 2.4% in value, all else being equal, and gain by that much should rates fall. The ETF charges a 0.3% expense ratio, or $30 annually for a $10,000 investment.
SPDR Bloomberg High Yield Bond ETF (JNK)
One of the benefits of high-yield bond funds is the potential for equity-like returns while not taking on excessive market risk. “When you think about a company’s capital structure, shareholders take the first losses, making that the riskiest position,” Wagner says. “High-yield bond holders could get equity-like returns, but if the company goes belly up, you actually have a claim against the liquidation value.”
A popular ETF pick for high-yield bonds is JNK, which tracks the Bloomberg High Yield Very Liquid Index. As its name suggests, this ETF prioritizes high-yield bonds with better liquidity, and spans a varied maturity range from one to up to 15 years. Right now, the ETF has an average yield to maturity of 9.3% against a duration of 3.7 years. JNK charges a 0.4% expense ratio.
Northern Trust High Yield Fixed Income (NHFIX)
“We break down the high-yield bond investment universe into cells that represent the types of risk present,” says Eric Williams, head of capital structure and senior portfolio manager at Northern Trust Asset Management. “Specifically, we identify opportunities by looking at ratings, sector and segments of the maturity curve to identify relative value as driven by fundamentals against a group of peers.”
This strategy underpins NHFIX, an actively managed high-yield bond mutual fund that places a high emphasis on managing downside risk while targeting above-average income potential. The fund currently features a concentrated 83% allocation to high-yield bonds from the industrial sector and sports an average yield to maturity of 9.6% against a duration of 3.7 years. NHFIX charges a 0.6% expense ratio.
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iShares Fallen Angels USD Bond ETF (FALN)
A special type of high-yield bond is the “fallen angel.” This term refers to the bonds of companies that were previously investment grade but have fallen from grace. Companies can lose investment-grade status for a variety of reasons, such as taking on excessive debt or missing bond payments. When this occurs, their bonds get downgraded to junk status and become fallen angels.
To capture fallen angels, investors can buy FALN, which tracks the Bloomberg US High Yield Fallen Angel 3% Capped Index. The benefit of this ETF is not only higher-than-average income, but also the potential for capital appreciation if the issuers in its portfolio regain investment-grade ratings. If this occurs, the price of the issued bonds can appreciate sharply. FALN charges a 0.25% expense ratio.
iShares High Yield Corporate Bond BuyWrite Strategy ETF (HYGW)
For even greater income potential, investors can consider HYGW, which combines the popular iShares iBoxx $ High Yield Corporate Bond ETF (HYG) with a covered call overlay. By selling monthly covered call options, HYGW caps its upside share price appreciation potential, but generates higher-than-average monthly income, especially during volatile range-bound market conditions.
Otherwise, the underlying portfolio of HYGW represents a typical broadly diversified high-yield bond universe index, with an average yield to maturity of 8.4% against a duration of 3.7 years. The covered call overlay isn’t a true hedge against downturns, but the increased income can cushion downside risk somewhat. The ETF charges a 1.19% expense ratio that is currently waived to 0.69%.
Vanguard High-Yield Corporate Fund Investor Shares (VWEHX)
Many high-yield bond ETFs and mutual funds feature higher-than-average expense ratios, a consequence of the greater effort it takes to manage these less liquid and riskier bonds. A notable exception is VWEHX, which like many Vanguard funds charges a low expense ratio of just 0.23%. For cost-conscious investors looking for high-yield bond exposure, this fund could be ideal.
VWEHX has been around since 1978 and has survived numerous market crashes and credit crises thanks to a focus on minimizing default risk and principal losses. Currently, this fund pays an average yield to maturity of 6.9% while sporting a low duration of 3.7 years. Since 1978 to present, VWEHX has returned an annualized 7.8%. However, do note that this fund requires a $3,000 minimum initial investment.
Invesco Senior Loan ETF (BKLN)
A unique high-yield bond ETF is BKLN, which primarily invests in leveraged institutional loans, also known as senior loans. These are loans made by banks to companies that already carry significant debt or have a poor credit rating. The term “senior” refers to the priority these loans enjoy in the company’s capital structure. In the event of default, senior loans are first in line to be made whole.
BKLN therefore allows investors to gain exposure to senior loans. Currently, this ETF sports a high average yield to maturity of 9.7%. Like many high-yield bond ETFs, BKLN does not exactly replicate its benchmark index. Rather, the ETF uses a sampling methodology to avoid more illiquid issues. BKLN currently charges a net expense ratio of 0.65%.
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7 of the Best High-Yield Bond Funds originally appeared on usnews.com
Update 05/24/23: This story was published at an earlier date and has been updated with new information.
