Better Junk

Date: December 1, 2013      Publication: Bottom Line Personal      Source: Robert M. Brinker      Print:

An investment that is commonly referred to as “junk” is not for the faint-hearted. Junk bonds—also known as high-yield bonds—tend to drop in price much more than other types of bonds when the economy falters. That’s because they are issued by companies whose ability to repay their debts may be questionable. Typically, yields on junk bonds are high enough to make up for the dangers. Lately, however, their average yield has sunk to record lows.

So why bother? Because there is a type of junk-bond mutual fund that has attractive enough yields and relatively low risk. These funds invest mostly in junk bonds that mature in three years or less. That means they are less vulnerable to the harmful effects of rising interest rates than funds investing in longer-term junk bonds. Short-term bonds with a credit rating of BB or lower held up well when rates spiked earlier this year. And defaults on these bonds will likely remain low as the strengthening economy makes it easier for companies to repay their debts.

Most attractive now…

Fidelity Floating Rate High Income Fund (FFRHX) invests in very short-term adjustable-rate loans that banks make to companies with low credit ratings. The yields on floating-rate loans typically reset every 90 days, so the fund’s share price tends to drop very little when interest rates rise. Recent yield: 2.6%. 10-year annualized performance: 4.5%.

Osterweis Strategic Income Fund (OSTIX) focuses on higher-quality junk bonds with an average “duration”—an indicator of interest rate sensitivity—of just 2.4 years. The fund also reduces volatility by shifting a big chunk of the portfolio to cash and ultrashort bonds in rocky times. Recent yield: 3.5%. 10-year annualized performance: 7.1%.

Source: Robert M. Brinker, CFS, editor and publisher of the Brinker Fixed Income Advisor newsletter, Littleton, Colorado.