Junk bonds are anything but

There are two familiar labels for corporate debt with Standard & Poor’s ratings lower than triple B: high yield bonds and junk bonds. I submit that both are obsolete, or at least misleading.

This is not to accuse Wall Street of double talk. In the past, much of this debt was indeed speculative and illiquid. But my experience, and yours if you’ve invested in the category since the 2008 fiscal crisis, is that these bonds flourish far more than they falter.

It’s history again in 2021: Upgrades to ratings below BBB are eight times more downgrades this year, including some promotions to the investment grade. The unfortunate side effect of this “rising stars” theme is that the current returns (what you get on new money) have declined. But with $ 18 trillion in bonds around the world priced below zero, and Goldman Sachs advertising its 0.5% Marcus online savings account as “high yield,” 4% is pretty high. .

I remain a huge fan. You should too.

A rewarding track record

The S&P High Return Index has a compound annualized total return of 6.8% over the past 10 years (through August 31) and a one-year return of 9.8%, compared to 5.0% and 2.8% for the S&P Investment Grade Bond Index. backed by S&P 500 companies.

Yes, you’re supposed to get extra return by taking on more default and downgrade risk – and you really do. Your goal should be around 4% income with more capital gains than losses over any reasonable holding period, allowing for occasional sales.

I am a booster for the active management of bond funds and not for indexation. Fidelity Capital & Income (FAGIX), a longtime Kiplinger favorite, has a one-year return (through September 10) of 21% and 8.5% annualized over 10 years.

If you think the small round of Capital & Income stocks skews this comparison, I’ll note that the purely below BBB bond fund offerings from American Century, Hotchkis & Wiley, Manning & Napier, Northern Trust, Payden & Rygel, PGIM and USAA have made a lot of hay this year and have been doing it for a long time with portfolios largely focused on B and BB rated bonds with yields to maturity today between 3.5% and 5.5%.

Among the closed funds, there is the incredible New America High Income (HYB), which is the T. Rowe Price High Yield fund in disguise. It has the same managers as T. Rowe’s flagship high-yield open-ended fund, but a better long-term track record, aided by the combination of slight leverage and frequent opportunities to buy good stocks. below the net asset value. HYB has a one-year return of 23% on its share price and a 12% fine if you measure by net asset value. In 2016 and 2019, its shareholders gained more than 30%.

My recent research and conversations have convinced me that this bounty is not over. “We are entering a huge upgrade cycle and at a record pace,” Michael Collins, PGIM bond strategist, said in a recent webinar.

Christopher Smart, Barings chief market analyst and global strategist, told me that wealthy international clients remain hungry for high-yielding US assets, including corporate bonds, private loan pools, real estate finance and high rate bank loans. When your hometown returns are negative, you have enough leeway to absorb any volatile trading period in the high yield market.

And the news trajectory is pointing upwards. There are serious discussions that Ford Motor (F) will regain the investment note it lost in March 2020, as the world ostensibly ended. To stay liquid, Ford issued bonds with coupons ranging from 8.5% to 9.625%. Its 10-year 9.625% bonds due 2030, still rated BB +, have climbed in value by 40% and are still valued for a yield of almost 4% at maturity. If the upgrade goes through, the funds that jumped on this paper last year will gain another windfall.