New Global High-Yield Bond Fund Offers Promise

TheStreet.com

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NEW YORK (TheStreet) -- In the last few weeks markets have reacted swiftly to the threat of the Federal Reserve beginning to "taper" its bond purchases and other accommodative policies. An end to the current Fed policy would result in higher yields and lower prices for bonds and bond funds.

To avoid further large declines in their bond fund portfolios, investors will need to seek out more alternatives that have less interest-rate sensitivity. This is where the new PowerShares Global Short Term High Yield Bond Portfolio can help.

The fund can own sovereign debt, quasi-government debt and corporate debt. It is a high-yield fund so the credit quality is low. The ratings breakdown allocates 48% to BB-rated debt, 24% B and 21% in C rated bonds.

PGHY is a global fund, which means it includes domestic debt. The U.S. is the largest country at 47%, followed by Luxembourg at 7% and smaller weightings to more emerging markets including the Ukraine, Lebanon and Venezuela. The holdings are denominated is U.S. dollars so there is no direct currency risk but a currency crash in Lebanon, for example, would adversely impact the price of any dollar denominated debt from that country.

It is too soon for there to be any definitive yield information for the fund but PowerShares reports that yield to worst (yield to worst means the least favorable situations where any debt is called in early) is 4.75%, which would be a very high yield considering that the effective duration is 1.75 years.

PGHY has 31 holdings in all and investors will be familiar with some of the names. The fund owns individual issues from Sirius XM, Chesapeake Energy and Ally Financial. Some of the more exotic holdings include Petroleos de Venezuela and Finansbank Turkey. With only 31 holdings, some of which have 4%-5% weightings, a default from even one bond would be a large drag on the fund's performance.

Bond investors face various types of risk including credit risk, which is risk of default, and interest rate risk, which is the adverse effect on bond prices when yields rise. PGHY takes credit risk but reasonably avoids interest rate risk. From the top down, an investor who believes there is still the threat of widespread defaults left over from the financial crisis would not want to invest in PGHY because the fund would indeed be hurt by such an outcome.

The current events in the capital markets merit closer attention here for their potential to impact upon PGHY. In May many segments of the bond market declined as investors started to price in a "tapering" of Fed policy. Then, this week, Fed Chairman Ben Bernanke laid out a scenario where quantitative easing could slow down this year and end next year.

This has caused a panic in the bond market. The yield on the 10-year U.S. Treasury has increased by almost a full percentage point in just a few weeks, which is a very large move.

Panics are difficult to see coming and difficult to analyze in terms of how long they might last. Panics can be recognized for what they are and so better managed emotionally. This is not the first time that there have been large declines in things like closed end funds, high-yield ETFs and other long dated bond funds and won't be the last time.

Investors interested in buying PGHY would be better off waiting for the panic to subside before considering a position in this new fund.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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