High-yield bonds have had terrific returns in recent years. In 2016, they outpaced both stocks and higher quality bonds. The Bloomberg Barclays U.S. Corporate High Yield index was up 17.13% compared to 11.96% for the S&P 500 and 2.65% for the Bloomberg Barclays Aggregate Bond index.
High yields may also be useful in a rising interest-rate environment, since their higher yields could help offset a decline in bond prices. In the second half of 2016, when the 10-year Treasury yield rose from 1.49% to 2.45%, higher quality bonds lost money while high yields gained over 6.5%.
You need to use high-yield bonds carefully, however, because these funds are risky. These are lower credit quality (“junk”) bonds, so they have a higher risk of default, and defaults tend to increase when interest rates rise.
High-yield bonds also can be quite volatile compared to other bonds. They are typically more correlated to stock markets, and that can make it hard for investors to hold these bonds long term. During the 2008 credit crisis, some high yield bonds lost 25-30%.
Ideally, you’d own high-yield bonds when they’re doing well and you’d avoid these bonds when they’re out of favor. This may seem unrealistic, and yet it’s what our fixed income approach is designed to do.
When to own (and when not to own) high-yield bonds
Our Flexible Income strategy has a proven track record of moving us into high yields when they have strong recent returns and steering clear of these bonds when they’ve lost momentum, as you can see in the chart below.
We didn’t have to predict how high yields were going perform in advance. Instead, we simply followed our strategy and bought into the funds that were excelling in the current market environment.
Use high-yield bonds as part of a diversified portfolio
We limit our exposure to high yields, and that’s one way that we’ve sought to mitigate the risk of these bonds in the Flexible Income Fund (INCMX). We also use these bonds as part of a diversified bond fund portfolio. Currently, we own high-yield bond funds along with floating-rate and strategic funds. For additional diversification, we also have exposure to total-return funds, which aren’t entirely invested in bonds. You can find INCMX's portfolio online at www.upgraderfunds.com.
FundX Flexible Income Fund
Navigating changing bond markets since 2002
Seeks to capitalize on potential gains from high-yield bonds
INCMX has a history of owning lower quality bonds, like high yields, when they’re doing well compared to other bonds and avoiding these bonds when they’re out of favor.
High-yield bonds have contributed to INCMX’s benchmark-beating performance for the past year and since inception. For the 12 months ending March 31, 2017, INCMX was up 5.76% compared to 0.44% for the Bloomberg Barclays Aggregate Bond index. INCMX returned 3.62% annually for five years; 4.02% annually for 10 years; and 5.09% annually since its July 1, 2002 inception. The index was up 2.34% for five years; 4.27% for the 10 years; and 4.45% since INCMX’s inception. The gross expense ratio for the Flexible Income Fund is 1.50%.
Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower or higher than the performance quoted. Click here for standardized performance of INCMX.
The Bloomberg Barclays Aggregate Bond index is an unmanaged index generally representative of intermediate-term government bonds, investment grade corporate debt securities and mortgage-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Bond index is a market value-weighted index which covers the U.S. non-investment grade fixed-rate debt market. The Bloomberg Barclays US Treasury 1-3 Year index measures the performance of U.S. Treasury securities that have a remaining maturity of at least one year and less than three years. You cannot invest directly in an index.
Publication Date: Upgrader Quarterly: Spring 2017