Investors digging for yield can still find it in these corporate bond funds

Published Thu, May 6 20212:16 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Investors looking for yield can still find it in corporate bonds, but they need to navigate carefully as interest rates rise. One of the simplest ways to invest in these bonds is through exchange-traded funds, which offer a wide selection with varying levels of risk. ETFs for investment-grade U.S. corporate bonds – those believed to have a lower risk of default – are currently yielding well above 3%. High-yield bond funds, which are riskier and have lower ratings from credit rating agencies, are yielding more than 4.5%. For instance, the VanEck Vectors Emerging Markets High-Yield Bond ETF yields 5.3% and it is trading just off its 52-week high of $24.05. The fund seeks to replicate the performance of the Bank of America Merrill Lynch High-Yield U.S. Emerging Markets Liquid Corporate Plus Index. Its holdings are U.S. dollar denominated bonds issued by emerging market entities, other than sovereigns and rated below investment grade. Michael Contopoulos, director of fixed income at Richard Bernstein Advisors, said he finds high-yield emerging market corporate debt attractive, and more so than U.S. high-yield debt. "High-yield emerging market corporate bonds actually have a lower default rate than U.S. high yield," he said. "One [reason] is because a lot of the high-yield emerging markets companies are national champions. Think Petrobras in Brazil." Some of the holdings in the VanEck ETF include Mexico's petroleum company, Petróleos Mexicanos, and Dubai port and logistics company DP World Ltd. "Emerging market debt generally has lower market sensitivity to U.S. interest rates...The higher the yield, the more cushion you have to absorb interest rate shock," Contopoulos said. Investors in bond funds need to be aware that if interest rates rise, prices fall and the value of their ETFs drop, just like the underlying bonds. U.S. high-yield bonds U.S. high-yield debt, or junk bonds, has seen strong demand this year. These bonds are rated below investment grade, due to their higher risk of default, and they have higher yields. Funds that hold them include iShares iBoxx $ High-Yield Corporate Bond ETF , with a yield of 4.55%. The SPDR Bloomberg Barclays High-Yield Bond ETF yields the same. Both funds were less than $1 from their 52-week highs Wednesday afternoon. Contopoulos likes the short end of that markett -- that is, a year or less. "Short maturity high-yield I think is attractive. It's not rate sensitive and the coupons are relatively high," he said. "In a cyclical environment going out of a recession, default risk gets front-loaded to early maturities." "If [a company] can make it through that six months, continue to pay the interest on debt, it's not going to have a problem sustaining its business and short-maturity high-yield actually trades like you're going to have relatively high defaults," Contopoulos added. "There's too much default risk priced into the front-end of the high-yield maturity curve. We think there's value there." The SPDR Bloomberg Barclays Short-Term High-Yield Bond ETF is an example of a fund that invests for that strategy. The ETF has a dividend yield of 4.82%, and its price is up about 1.5% year-to-date. Top-rated corporate bonds Investment-grade corporate bonds are attractive investments, but if rates rise too quickly, they could get hurt. IG corporate bond funds have decent yields, but lower than high-yield funds. The iShares 10+ Year Investment Grade Bond ETF was yielding 3.34%, but its price is currently about $7 below its 52-week high of $74.42, reached in August. The Vanguard Long-Term Corporate Bond Index Fund ETF yields 3.23%, and its price is about 7% lower on the year. "There's two components to corporate bonds. You have the interest rate component and you have the credit risk," said Contopoulos. "The interest rate component is going to hurt you, but the credit risk component, the spread between the corporate bond yield and the Treasury yield, I think there's still room to compress," he said. Contopoulos said there are ways to hedge against some of the interest rate risk through a selection of specific corporate bond ETFs. The ProShares Investment Grade Interest Rate ETF is an example of a corporate bond fund that hedges against rising interest rates. The fund seeks results that track the performance of the Citi Corporate Investment Grade (Treasury Rate-Hedged) Index. The index is comprised of long positions in investment-grade bonds issued by U.S. and foreign entities and short positions in U.S. Treasury notes and bonds. The ETF yields 2.52% and it was trading near its 52-week high. "I think on a spread basis, not on an all-in yield basis, we still like long maturity investment grade corporate bonds. That's where a lot of issuance happened in 2020," said Contopoulos. "Thirty-year investment grade corporate bonds, on a spread basis those corporate bonds look attractive to us. If you could hedge out the interest rate risk, you could do well." Contopoulos said investors need to think about where the best spots are in the fixed income market for the next one to three years. "It's going to be difficult to make a total positive return in fixed income." He said individual investors will need to use products that can help them hedge their holdings in different ways. "ETFs allow investors to do sophisticated things that five years ago they weren't able to do," Contopoulos said.

American flags hang from the facade of the New York Stock Exchange (NYSE) building in New York January 28, 2021.

Mike Segar | Reuters

Investors looking for yield can still find it in corporate bonds, but they need to navigate carefully as interest rates rise.

One of the simplest ways to invest in these bonds is through exchange-traded funds, which offer a wide selection with varying levels of risk.

ETFs for investment-grade U.S. corporate bonds – those believed to have a lower risk of default – are currently yielding well above 3%.

High-yield bond funds, which are riskier and have lower ratings from credit rating agencies, are yielding more than 4.5%.

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