After a brutal 20%-plus decline over the past eighteen months, the junk bonds market has perked up, reclaiming some of those losses.
Is this the start of a comeback for junk bonds, especially considering some $5 billion of capital flowed into the sector at the beginning of March? The answer is: possibly.
First, a quick review on junk bonds. These are bonds issued by companies that are not in the best financial shape. They often have a lot of debt, and junk bonds are often pretty far down in the capital stack and/or are unsecured. Therefore, should the company that issued the debt go bankrupt, it is the senior lienholders and secured bondholders that get first bite at any assets — junk bond holders likely get nothing.
In exchange, junk bonds get paid much higher rates of interest, often 8.5% to 11%.
Junk Bonds to Buy: SPDR Barclays High Yield Bond ETF (JNK)
Expenses: 0.4%, or $40 per $10,000 invested
The SPDR Barclays High Yield Bond ETF (JNK) bottomed at $31 and is currently trading around $34. It’s a good example of a junk exchange-traded fund.
Any kind of company can issue junk bonds. JNK contains issuances from communications firms, telecom firms, health insurers, manufacturers … and energy. It yields 6.7%.
A lot of junk bonds were issued a few years ago by shale oil producers. They need a lot of capital to go drilling for oil.
When oil prices were high, bondholders assumed that the shale producers would pull out more than enough oil to make good on interest payments.
Then oil prices collapsed, and the shale producer junk bond market went into crisis. That’s what helped pull the entire sector down. Things got exacerbated at the beginning of the year when the whole market stumbled and things looked like they might collapse.
That may be turning around, so JNK is one possible choice.
Junk Bonds to Buy: AdvisorShares Peritus High Yield ETF (HYLD)
AdvisorShares Peritus High Yield ETF (HYLD) is another popular choice if you are thinking about getting into junk bonds now via an ETF. The prices have not been this low since the financial crisis, so that’s very tempting, and that explains the 11.1% yield.
HYLD also has a wide variety of sectors and companies. There’s food companies, graphics, communications, precious metal miners and tech companies. With HYLD, it’s diversified enough that I think there’s some merit to opening up a half position.
For HYLD, like JNK, the bullish argument is that these securities have sold off pretty heavily and are near those 2009 lows. We want to choose carefully, and evaluate the largest holdings of a given fund to see what the financial positions of those companies are like, and this one has some very solid candidates.
Junk Bonds to Buy: iShares iBoxx $ High Yield Corporate Bd (HYG)
If you want that energy exposure that may lift the price of your ETF more quickly but aren’t comfortable with a 17% energy position, the iShares iBoxx $ High Yield Corporate Bd (HYG) has 10% energy exposure.
If you believe that oil prices have stabilized, you might want to get into HYG, which is still heavily weighted in energy. After all, oil prices did move above $37, clearing a band of resistance. That means energy junk bonds are going to stabilize as well.
When you add in the high yields of these funds, there’s an argument for going long. The fact that HYG yields 6.1%, which is low for a junk bond fund, also suggests it carries reasonable risk.
However, there are arguments against getting involved here. It depends on your risk tolerance.
If oil falls again, I think junk bonds will sell off again. If the market goes back to its losing ways — and I believe we will end the year much lower than where we are now — that could trigger a sell-off as well.
If both of those things happen, then look out below.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.