Junk bonds, and the mutual funds investing in them, had a difficult 2015. But that doesn’t mean investors should ignore this high-yield area of the market now.
Instead, the market for junk bonds in 2016 requires one particular virtue — selectiveness.
Stay far away from the funds that have excessive allocations to the distressed and illiquid. Simply put, pick your junk with the tenacity of a dumpster diver.
Exemplary of junk bonds to avoid: Third Avenue Focused Credit (TFCIX), which closed to investors on Dec. 10 and was placed into liquidation by its board of trustees.
TFCIX had focused allocations of 5% or more on distressed names like Clear Channel Communications (CCO). By its closure, TFCIX had lost 30% in 2015, whereas the average high-yield bond fund shed just about 4%.
So with the lessons learned over the past year, the best junk bond funds to buy now are broadly diversified among the higher quality junk bonds.
Best Funds for Junk Bonds: Fidelity Short Duration High Income (FSAHX)
SEC Yield: 6.34%
Minimum Initial Investment: $2,500
Looking for high yields while balancing credit and interest rate risk? Take a gander at Fidelity Short Duration High Income (FSAHX).
Although the fund opened relatively recently in November 2013, FSAHX finished 2015 ahead of the average high-yield bond fund with a loss 3.3%. That might sound poor, but that’s compared to an average 4% loss for its category peers.
And the downside risk won’t scare off investors so long as yields remain strong. To this end, FSAHX is well diversified with 184 holdings (most of which are corporates), such as Dynegy Inc (DYN), T-Mobile (TMUS) and Sprint (S).
The average credit rating of “B” for the fund’s holdings is solidly junk, but is in alignment with average high-yield bond funds.
Best Funds for Junk Bonds: Vanguard High-Yield Corporate Fund (VWEHX)
SEC Yield: 6.33%
Minimum Initial Investment: $3,000
The Vanguard High-Yield Corporate Fund (VWEHX) ranks among the best junk bond funds on the market.
It’s tough to beat a low-cost, well-managed fund that kicks off high yields like VWEHX. And VWEHX shareholders enjoy above-average returns — in 2015, VWEHX beat 85% of the high-yield category with loss of just 1.3%.
But it’s the long-term picture that looks rosy: VWEHX’s 5.95% 10-year annualized return bests two-thirds of category peers.
VWEHX could fare better than its peers through potential challenges for junk bonds, with its corporate bonds averaging a “B” credit rating. The fund is very well diversified with 386 holdings, most of which represent less than 1% of assets.
Best Funds for Junk Bonds: Fidelity Capital & Income (FAGIX)
SEC Yield: 4.27%
Minimum Initial Investment: $2,500
For investors who like their junk bonds aggressively mixed with stocks, Fidelity Capital Income (FAGIX) may be the best on the market.
The FAGIX portfolio was recently about 70% bonds, 20% stocks and 10% cash. Like many of the best junk bond funds you’ll find, the bond holdings average a “B” credit rating; placing it firmly in the junk category but not too deep into risk. Further, the bonds are primarily corporates.
The junk bond and equity combination has resulted in outstanding long-term returns, including a 7.5% 10-year and 8.1% 15-year annualized returns, both of which rank in the top 1% for high-yield bonds, even beating the S&P 500 Index.
With over 500 bond holdings and 91 stock holdings, FAGIX has the kind of diversification needed for volatile markets where too much exposure to risky assets is portfolio anathema.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. However some of his clients hold AGG. His No. 1 holding is his privately held investment advisory firm in Hilton Head Island, SC. Under no circumstances does this information represent a recommendation to buy or sell securities.