In a low-interest-rate environment, high-yield bonds are living up to their names, generating substantial interest income, says Mark Hudoff, portfolio manager of Hotchkis & Wiley High Yield in Corona del Mar, Calif. Even after defaults, investors still earned above-market returns that beat investment grade, he said. Indeed, his fund has had a trailing 12-month yield of 5.4% over the past year, according to Morningstar.
Currently, he says, high-yield bond funds are earning roughly 4 percentage points above Treasuries, and defaults are just above 1%. While high yield defaults are on the rise--estimates call for a rate of 1.5% to 2% before the end of 2015--they are still well below the long-term average of about 4.4%. All of that makes high-yield an attractive option compared to investment-grade bonds. Even if the high-yield funds take some defaults, say for 50 basis points, they still can produce as much as three times the yield of investment-grade bonds. Income, while attractive, isnt the only reason to consider high-yield bonds. They also have a very low correlation with Treasuries an average of 0.4. Bonds rated single-B have an even weaker link to the Treasury market. Compare that to an almost one-to-one correlation between investment grade bonds and Treasuries, Hudoff says.
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