Is It Safe To Invest In High Yield Corporate Market?

By Larry Swedroe, on April 5, 2009

In this Ask the Expert with Larry Swedroe article, Randy is wondering if it’s time to go back into the high yield corporate market. However, he’s concerned that the recent market rally may be just a bear market rally. Here’s the question from Randy:

Is it safe to enter into the high yield corporate market yet, seeing that ETFs such as HYG and JNK are still near their 52-week lows, but heading higher. One would think that as the stock market rebounds, these funds should also. But, I am concerned that if the market took a down turn (i.e., if we are in a bear market rally), whereas normally these funds should react inversely to the market, they could once again synchronize with the equity markets and lose some of their value. Thanks, Randy

Answer From Larry Swedroe

Great question. What most people don’t understand is that high yield bonds are really not bonds, but are what would are more appropriately called hybrids. Depending on the credit rating the percentage that is really equities will vary. For example, the Vanguard high yield fund is really about 22% equities and a CCC fund would be like 50%. So if you buy such a fund you need to adjust your asset allocation to reflect the fact you are taking a lot more equity risk.

Another problem is one of location. You should prefer to hold equity risk in taxable accounts and bond risk in tax advantaged accounts and with a hybrid (be it junk, preferred, convertibles or even EM bonds) you are holding one of the risks in the wrong location, assuming you have a choice of location. Moreover, you can get the Treasury exposure (the bond portion) without paying the high expenses of a mutual fund.

Bottom line is that while I agree that expected returns are now high (because the risks are now high), you are significantly better off simply increasing your exposure to small and value stocks instead — and stick with Treasury Inflation-Protected Securities (TIPS) for your bonds in tax advantaged accounts. That is a much more efficient way of taking risk. You can read more about why I don’t recommend any hybrids in The Only Guide to Alternative Investments You’ll Ever Need.

I hope the above is helpful.

Best wishes,

Larry

Disclaimer

• Mr. Swedroe’s opinions and comments expressed are his own, and may not accurately reflect those of the firm, nor Moolanomy and its owner.
• Not all questions will be answered
• By submitting a question, you grant us the right to publish your question.
• The answer is given based on the information provided in your question. Please seek professional assistance for more personalized advice.

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Larry Swedroe is a principal and director of research at Buckingham Asset Management, LLC, an SEC Registered Investment Advisor firm in St. Louis, Missouri. He is also principal of BAM Advisor Services, LLC, a service provider to investment advisors across the country, most of whom are affiliated with CPA firms. However, his opinions and comments expressed within this column are his own, and may not accurately reflect those of Buckingham Asset Management or BAM Advisor Services. Before joining Buckingham in 1996, Larry served as senior vice president and regional treasurer at Citicorp and vice chairman of Prudential Home Mortgage. Larry is author of The Only Guide to a Winning Investment Strategy You'll Ever Need (updated and re-released in 2005), as well as six other books. Most recently, he authored The Only Guide to Alternative Investments You'll Ever Need (2008). Larry has started his own blog called Wise Investing at CBS Money Watch. Please check it out!

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