What are the substitutes for corporate Bonds

Investors became increasingly interested in high-yield bonds as long-term Treasury yields fell to record lows during 2019. The Federal Reserve repeatedly reduced interest rates in 2019, leaving many investors searching for higher yields in 2020. High-yield bonds carry more risk than Treasury bonds, yet many investors are being pushed into this market.

Different strategies are necessary for high-yield corporate bonds. While it is perfectly safe to buy Treasuries directly, individual high-yield bonds carry high default risk. The best way for small investors to deal with default risk is through diversification. Fund managers have the resources to buy a wide selection of high-yield corporate bonds, reducing default risk. They also try to find the best bonds to buy.

However, investors still need to choose between high-yield bond funds. All high-yield funds are slightly different, but most investors will find what they are looking for among our top five high-yield bond funds for 2020. Some emphasize lower risk, which is a good place to start for those new to high-yield bonds. Others offer low fees, which are more important now because of lower yields.

1. Fidelity Capital & Income Fund (FAGIX)

Created in 1977, the Fidelity Capital & Income Fund invests in both equity and debt securities, with an emphasis on lower-quality debt securities. The fund also focuses on companies facing financial difficulties. It had $12.08 billion in assets under management (AUM) as of November 2019.

It paid a 30-day Securities and Exchange Commission (SEC) yield of 3.75%. The debt securities in the fund's portfolio had an average weighted maturity of 6.80 years and a duration of 3.35 years. That is a lower duration, which indicates the bonds have less exposure to interest rate risk. The fund had a reasonable expense ratio of 0.69% and had an average ten-year return of 8.31%.

The Fidelity Capital & Income Fund's top three sectors were fixed-income instruments from energy companies, banks, and technology firms. These three sectors comprised a combined 34.99% of their holdings in September 2019. There is no minimum investment requirement.

2. Vanguard High-Yield Corporate Fund Investor Shares (VWEHX)

The Vanguard High-Yield Corporate Fund focuses on corporate debt with lower credit ratings. The fund manager seeks out higher-rated junk bonds. Vanguard states that this approach is intended to return consistent income while minimizing defaults and principal loss. The fund does have higher volatility, closer to that of the stock market.

The fund has a low expense ratio of 0.23%, and it drops to 0.13% for investors who can afford the $50,000 minimum for Admiral Shares. The fund had net assets of $26.2 billion and a 30-day SEC yield of 4.48%. There were 525 bonds in the portfolio, with an average effective maturity of 3.7 years and an average duration of 3.0 years as of October 2019. The average annual return for this relatively conservative high-yield fund was 7.25% over the last ten years.

The Vanguard High-Yield Corporate Fund held 19.9% of its assets in the communications sector, followed by 13.2% in consumer cyclical, and 12.5% in capital goods. Ba3 rated bonds formed the largest portion of the portfolio at 20.7%, followed by Ba1 bonds at 16.1%. The fund required a minimum investment of $3,000.

3. BlackRock High Yield Bond Fund (BHYCX)

The BlackRock High Yield Bond Fund, which began trading in 1988, invests in low-rated bonds with maturities of ten years or less. At least 80% of assets are invested in high-yield bonds, which include convertible securities. In December 2019, the fund had $17.31 billion in AUM. The 30-day SEC yield was 3.93% in October 2019. The average annual return over the last ten years was 6.94% as of November 2019.

Around 42% of the BlackRock High Yield Bond Fund's holdings are rated B, and another 33% of its holdings have BB ratings. The fund had over 1,200 holdings in its portfolio. The expense ratio was 1.64% for individual investors and 0.61% for institutional investors. The fund distributes its yields every month.

4. SPDR Bloomberg Barclays High Yield Bond ETF (JNK)

Exchange-traded funds (ETFs) that invest in high-yield bonds may be appropriate for investors who are focused on fees. ETFs avoid many of the expenses and minimums that are typically associated with mutual funds. The fund tracks the performance of the Bloomberg Barclays High Yield Very Liquid Index. The fund had net assets of $10.18 billion and paid a 30-day SEC yield of 5.20% as of December 2019. The average ten-year annual return was 6.64% as of September 2019.

The largest sector allocation for the fund is industrials, with a weighting of about 87%. The fund has an expense ratio of 0.40%. In terms of the quality of holdings, around 50% of the assets were rated BB, and 37% were rated B.

5. iShares iBoxx $ High Yield Corporate Bond ETF (HYG)

The iShares iBoxx $ High Yield Corporate Bond ETF is another ETF that provides broad exposure to U.S. high-yield corporate bonds. It had net assets of over $18.99 billion and paid a 30-day SEC yield of around 4.83% as of December 2019. The fund had 1,006 holdings and an expense ratio of 0.49%. The ten-year average annual return was 6.56% as of November 2019.

This fund has a relatively high beta, which demonstrates that it has greater volatility than some more conservative bond funds. The fund began trading in 2007. 

KEY TAKEAWAYS

  • High-yield bond funds invest in "junk" bonds—lower credit quality corporate bonds that carry an above-market yield.
  • Investors look to high-yield bonds to earn a better return than low-yielding, but safer, government and investment-grade corporate bonds.
  • Owning high-yield bonds comes with higher default risks unique to this part of the fixed-income market, making diversification via bond funds essential.

Looking at average annual returns over the last ten years is generally an excellent way to compare the management of high-yield corporate bond funds.