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‘Junk’ Bonds are Anything But

There are two familiar labels for corporate debt with Standard & Poor’s credit ratings weaker than triple-B: “high-yield bonds” and “junk bonds.” It can be argued that both are obsolete, or at least misleading, notes Jeffrey R. Kosnett, editor, Kiplinger’s Investing for Income newsletter.

That is not to accuse Wall Street of doublespeak. Once upon a time, much of this debt was indeed speculative and illiquid. But if you have invested in the category since the 2008 fiscal crisis, you’ll have noticed that these bonds flourish way more than they falter.

That’s the story again in 2021: Below-BBB ratings upgrades outnumber downgrades this year by eight to one, including some promotions to investment grade. The unfortunate side effect of this “rising stars” theme is that current yields (what you get on new money) have dwindled. But with $18 trillion of bonds worldwide priced to pay less than zero, and Goldman Sachs advertising its 0.5% Marcus online savings account as “high yield,” 4% is high enough.

S&P’s high-yield index has a compound annualized total return of 6.8% for the past 10 years (through August 31) and a one-year return of 9.8%, compared with 5.0% and 2.8% for S&P’s index of investment-grade bonds backed by companies in the S&P 500. Yes, you are supposed to get extra return for taking on more risk of defaults and downgrades – and you truly do.

Your target should be about 4% income with more capital gains than losses over any reasonable holding period, which allows for the occasional sell-off.

Fidelity Capital & Income (symbol FAGIX) has a one-year return (through September 10) of 21% and 8.5% annualized for 10 years. If you think that Capital & Income’s small sleeve of stocks distorts this comparison, note that pure below-BBB bond-fund offerings from American Century, Hotchkis & Wiley, Manning & Napier, Northern Trust, Payden & Rygel, PGIM and USAA have made plenty of hay this year, and they’ve succeeded for a long time with portfolios centered largely on bonds rated B and BB with yields to maturity today between 3.5% and 5.5%.

“We are embarking on a huge upgrade cycle and at a record pace,” PGIM bond strategist Michael Collins said in a recent webinar. And the news trajectory is pointing up.

There’s serious talk that Ford Motor will win back the investment-grade rating it lost in March 2020. To stay liquid, Ford issued bonds with coupons of 8.5% to 9.625%. Its 10-year 9.625% bonds due in 2030, still rated BB+, have soared in value by 40% and are still priced to yield nearly 4% to maturity. If the upgrade comes through, funds that pounced on this paper last year will earn another windfall.

Editor’s Note: Jeffrey R. Kosnett is editor of Kiplinger’s Investing for Income newsletter,

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