Are Junk Bond ETFs Right for Your Portfolio?

i_love_junk_bonds_keychains-r0727138b1a624ba4a2dfb67b5919d13a_x7j3z_8byvr_324There are some great reasons to praise the advent of ETFs.  They allow you to invest in a diversified portfolio of a given type of security, so that you don’t have to pick  and choose among individual securities that will increase your risk exposure.

One of the ETFs that bond investors should have a good look at is the SPDR Barclays High Yield Bond ETF (NYSE:JNK).  It’s a good idea to have some exposure to high yield bonds in your portfolio, and doing so via an ETF gives you the safety of diversification to reduce the risk these securities would normally carry individually.

The JNK ETF is attractive for many reasons. It tracks the performance of the Barclays High Yield Very Liquid Index, so it only invests in high yield bonds that have the liquidity to permit rapid purchases and exits.  Nor is it required to purchase all of the securities in the index.  It can purchase a subset and filter out ugly holdings.

80% of the funds assets will be from this index.  These are fixed rate taxable corporate bonds with a maturity of at least one year, and rated BB+ by S&P or below, and have at least half a billion dollars of face value.  It has a 0.40% management fee, so it isn’t terribly expensive.  It carries 748 different securities with average duration of about 6.58 years.

In fact, 20% of the holdings have maturities of 3 to 5 years, 40% are 5 to 7 years, and 35% are 7 to 10 years.  40% are rated BB, 43% are rated B, and 17% are rated CCC or lower.

Its performance has been very strong.  After a miserable 2008, when it lost 30% (while the market fell 55%), it roared back 50% in 2009, 14% in 2010, 4.7% in 2011, and 14.3% in 2012.  It has returned 6.58% in the past year, and 6.78% annually since inception in late 2007.

The average price of each bond in the portfolio is $100.97, so obviously there’s a good demand for junk bonds since the average trades over par.  The Average yield to maturity, in the worst case scenario, is 6.47%, the current yield is 6.84%, and dividend yield is 5.98%.

What kind of bonds does the ETF actually hold.  There are bonds from many familiar names and that should give you some comfort because these are solid companies, and many of them simply aren’t going to default.

This includes: First Data Corp, Sprint, Chrysler, HCA, Tenet Healthcare, Reynolds Group, HJ Heinz, Roayl Bank of Scotland, Softbank, Ally Financial, Valeant Pharmaceuticals, Echostar, GM, Davita Healthcare, Clear Channel, Linn Energy, T-Mobile, CIT Group, MBC Software, Harrah’s, Telecom Italia, Chesapeake Energy, US Foods, CenturyLink, and Calpine…just to name a few.

People can get greedy with yield, but can also be scared.  The JNK ETF is a good choice.  There will be times when the junk bond sector sells off just because the market panics, but that’s not what you should be worried about.  You can move out of this if interest rates start to rise significantly.  In the meantime, buy some high yield ETF so you have some exposure.

Lawrence Meyers does not own any securities mentioned.

About Lawrence Meyers
 lawrence meyersLarry is regarded as one of the nation’s experts on alternative consumer finance. He consults for hedge funds and private equity via his Council Member status at Gerson Lehman Group, and as a member of Coleman Research Group’s Executive Forum. He also consults for Credit Access Businesses and Credit Services Organizations in Texas. His Op-Eds and Letters to the Editor have appeared in over two dozen major newspapers. He also brokers financing, strategic investments, and distressed asset purchases between private equity firms and businesses of all stripes. You can reach him at [email protected]

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