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Despite Record Low Yields, This Bond Fund is a Big Buy

Closed-End FundsI won’t try to conceal it. Treasury bonds these days give me the heebie-jeebies. On Wednesday, the benchmark 10-year yield closed at a razor-thin 1.99%. Not only is that a long way from the 15.5% I remember so well in September 1981, 30 years ago, it’s also essentially the lowest yield on record for a bond of this maturity since the founding of the Republic.

What are these ultra-low Treasury yields (including the near-zero yields on short-term bills) telling us? Certainly, they’re warning us to be careful. If there were an abundance of high-return investment opportunities in today’s economy, Uncle Sam would find himself locked in a fierce competition for credit. The Treasury could never borrow at these rock-bottom rates.

At the same time, it’s likely that low Treasury yields reflect, at least to some extent, lingering fears — not all of them rational — from the global financial crisis of 2008. Some investors are so petrified by the memory of that experience that they’re willing to accept Treasury yields that guarantee a negative return after inflation and taxes. That’s the irrational element in today’s Treasury market.

Where the Values Are Now

From month to month, though, some regions of the bond market can offer significantly better value than others. Right now, I’m intrigued with the higher-yielding niches within the corporate and mortgage sectors.

Admittedly, high-yield securities of any kind always carry special risks. In this case, however, I suspect fearful investors are exaggerating the problems — and underestimating the potential returns from these bonds.

For example, we know corporate profits in the United States recently have broken out to a new all-time high. Corporations also are sitting on fatter cash reserves, as a percent of total assets, than at any time since the late 1950s. If the nation were to plunge back into a deep economic slump, businesses undoubtedly would feel the pinch. But corporate America is in far better shape to weather a recession today than, say, in 2007.

Despite these strong fundamentals, bonds issued by corporations with less-than-pristine credit continue to throw off unusually high yields by historical standards. As a matter of fact, the “junk” bonds in the Merrill Lynch High-Yield Bond Index now pay a handsome 8.7%, up from just 6.8% as recently as May 2011. Meanwhile, the 10-year Treasury yield has dropped more than 100 basis points.

I’m not urging you to rush out and buy a lot of junk. However, I think you can safely dip your toe into one of the more conservatively managed funds in this area, the Vanguard High-Yield Corporate Fund (MUTF:VWEHX, $3,000 minimum). VWEHX yields 7.3% — lower than the Merrill index thanks to Vanguard’s emphasis on better-quality credits, but far more than a 2% Treasury.

What to Do Now

Buy VWEHX at $5.65 or less. Monthly distributions. There’s no sales charge if you buy directly from Vanguard. However, the fund does impose a 1% fee if you redeem within the first year.

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