Fallen angel bonds, a higher quality derivative of traditional junk debt, offer investors the opportunity to generate income with high yields while possibly catching some capital appreciation along the way.
The S&P 500 is trading around 17 times earnings, its highest in seven years, David Giroux, T. Rowe Price Capital Appreciation manager, said in a Morningstar article.
On the fixed-income side, bonds are typically more attractive when stocks look somewhat expensive, but fixed-income assets have been pushed up, with interest rates still relatively low.
Consequently, Giroux believes that higher quality, speculative-grade debt may be one area where investors can find value.
“I would say the one area of both fixed income and equities where we see a little bit of value is what I would call the highest-quality high-yield bonds–companies that we think are sort of money-good, if you will, even in a difficult economic environment where you’re earning 4% to 5% for really high-quality BB bonds,” Giroux said in the article.
Investors interested in targeting this area of the market can take a look at the Market Vectors Fallen Angel High Yield Bond ETF (ANGL) , which tracks high-yield, junk bonds that were originally issued with an investment-grade rating. The fund has a 5.18 year duration and a 4.12% 30-day SEC yield. [Fallen Angel Bond ETF Offers Robust Yield]
ANGL offers a better debt profile than other high-yield funds. The ETF has a 73.2% allocation to BB-rated debt, 16.4% in B-rated debt and 6.0% in CCC-rated debt. Anything rated BB and below is considered speculative grade or junk. [Junk Bonds, ETFs See Default Rates Drop to 2008 Low]
The shift to income-oriented strategies over the past couple of years has pushed down yields and helped junk bonds rally.
“When we think about high-yield in general, we think high-yield is a little bit of a bubble, but most of that bubble is really on the CCC credits and the B credits, where spreads are well inside of history,” Giroux added. “We think the highest-quality BBs look attractive relative to equities and relative to the fixed-income market in general.”
In comparison, the more popular junk bond ETFs, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and SPDR Barclays High Yield Bond ETF (JNK) include bonds with lower credit quality. HYG credit quality allocations include: BB 46.%, B 26.44% and below B 10.5%. JNK includes BB 38.8%, B 41.6% and CCC or lower 19.1%.
However, the tilt toward riskier debt provides higher yields. HYG has a 4.47% 30-day SEC yield and JNK has a 4.80% 30-day SEC yield.
For more information on speculative-grade debt, visit our junk bonds category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.