Are high yield bond ETFs worth it?
Because of the additional risk associated with high-yield bonds, investors also have the potential to earn higher returns compared to safer bonds. Yields for these non-investment-grade bonds are higher than government bonds, meaning investors can earn more in income relative to the price they paid for the bonds.
These bonds are inherently more risky than bonds issued by more credit-worthy companies, but with greater risk also comes greater potential for return. Identifying junk bond opportunities can boost a portfolio's performance, and diversification through high-yield bond ETFs can cushion any one poor performer.
"Long-term bond ETFs invest in bonds with maturities of more than 10 years, are more sensitive to interest rate changes and may experience greater volatility in their returns," Moss says. "They are suitable for investors who have a long-term investment horizon and can tolerate higher levels of risk."
High-quality bond investments remain attractive. With yields on investment-grade-rated1 bonds still near 15-year highs,2 we believe investors should continue to consider intermediate- and longer-term bonds to lock in those high yields.
What are the risks? Compared to investment grade corporate and sovereign bonds, high yield bonds are more volatile with higher default risk among underlying issuers. In times of economic stress, defaults may spike, making the asset class more sensitive to the economic outlook than other sectors of the bond market.
In other words, bond ETFs are at risk if the borrower defaults as this means they may not pay the entire amount of the bond back. While there is no debt to an equity ETF, the underlying companies can still incur losses and lose value.
Yes, high-yield corporate bonds are more volatile and, therefore, riskier than investment-grade and government-issued bonds. However, these securities can also provide significant advantages when analyzed in-depth. It all comes down to money.
For many investors, investing in the right bond funds can be a better option than holding a portfolio of individual bonds. Bond ETFs can provide better diversification — often for a lower cost — can offer higher liquidity, and can be easier to implement.
Bond ETFs can lose value due to several factors, including changes in interest rates, credit risk, and market sentiment. When interest rates rise, the prices of existing bonds, which have lower interest rates compared to new bonds, tend to fall. Since a bond ETF holds many such bonds, its value can decrease as well.
| Total Bond Market ETF | 1-yr | 3-yr |
|---|---|---|
| Returns after taxes on distributions and sale of fund shares | 0.93% | -2.26% |
| Average Intermediate-Term Bond Fund | ||
| Returns before taxes | 2.01% | -2.45% |
| Returns after taxes on distributions | — | — |
Why not to invest in high yield bonds?
What are the risks? Compared to investment grade corporate and sovereign bonds, high yield bonds are more volatile with higher default risk among underlying issuers. In times of economic stress, defaults may spike, making the asset class more sensitive to the economic outlook than other sectors of the bond market.
High-yield bonds tend to perform best when growth trends are favorable, investors are confident, defaults are low or falling, and yield spreads provide room for added appreciation.
Looking at the asset class's historical performance leads us to believe that high yield is poised to produce a positive return in 2024, albeit not as robust as that experienced in 2023. We believe that the economy is not rolling over and that a recession is likely to be at least six months away.
Given the numerous reasons a company's business can decline, stocks are typically riskier than bonds. However, with that higher risk can come higher returns.
Key takeaways. High-yield bonds may offer greater yield and return potential than investment-grade bonds, in exchange for higher credit risk. The overall credit quality of the high-yield universe has been improving in recent years and is at historically strong levels.
High Yield Savings Accounts: Ideal for short-term goals and for those who want liquidity with better-than-average returns. Bonds: Best suited for long-term investors who can afford to lock away their money in exchange for stable, predictable gains.
Bottom line. Bond ETFs really can provide a lot of value for investors, allowing you to quickly diversify a portfolio by buying just one or two securities. But investors need to minimize the downsides such as a high expense ratio, which can really cut into returns when interest rates are low.
| Ticker | Fund | 1-Mo Return |
|---|---|---|
| BLV | Vanguard Long-Term Bond ETF | 9.98% |
| ZROZ | PIMCO 25+ Year Zero Coupon US Treasury ETF | 16.02% |
| VCIT | Vanguard Intermediate-Term Corporate Bond ETF | 5.95% |
| IEF | iShares 7-10 Year Treasury Bond ETF | 4.55% |
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
Meketa Investment Group recommends that most diversified long-term pools consider allocating to high yield bonds, and if they do so, between five and ten percent of total assets in favorable markets, and maintaining a toehold investment even in adverse environments to permit rapid re-allocation should valuations shift.
What happens to bond ETFs during recession?
The bond market is inversely correlated with the federal funds rate and short term interest rates. When interest rates drop during a recession, bond prices increase, and bond yields decrease. During periods of economic growth that follow a recession, interest rates start to increase.
| Bond name | Rating |
|---|---|
| 8.80% L&T FINANCE LIMITED INE027E07AP2 Secured | INDIA AAA |
| 12.15% VATIKA SEVEN ELEMENTS PRIVATE LIMITED INE0DFG08296 Unsecured | Unrated |
| 8.50% HAZARIBAGH RANCHI EXPRESSWAY LIMITED INE526S07197 Secured | INDIA D |
Bond ETFs pay dividends on a monthly basis based on the interest income earned on the bonds held in the fund's portfolio.
Bonds are often touted as less risky than stocks—and for the most part, they are—but that does not mean you cannot lose money owning bonds. Bond prices decline when interest rates rise, when the issuer experiences a negative credit event, or as market liquidity dries up.
What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
