Important Updates for Investors
Carla Pasternak's Premiere Issue of High-Yield International Just
Released
Income expert Carla Pasternak's debut issue of High-Yield
International covers a Taiwanese manufacturer yielding 9.5%... a
rare Mexican monopoly yielding 13.4%... and other top-performing
investments yielding up to 19.0%.
Government's Biofuel Timetable Could Spell +15,900% Growth
+15,900% growth might seem far-fetched... but it's not. In fact, it
is mandated by law. And I've identified the ONLY stock positioned to
capture this growth.
The
Silver Lining to a Falling Dollar
Despite the U.S. national debt, there is a silver lining for income
investors. This massive spending, combined with movement out of U.S.
Treasuries, is going to take its toll on the dollar, and
international income investors could reap the rewards in the form of
higher dividends. |
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Rake in
Bond Yields 600 Basis Points Above U.S. Treasuries |
Published: February 18, 2008
As the name implies, high-yield bonds are debt securities that
offer extremely generous interest rates. The downside, of
course, is that these bonds are issued by companies with less
than stellar credit ratings. So to capture that higher yield,
investors must also assume a higher degree of risk.
That potential headache has frightened many investors away from
the high-yield sector. However, at times this asset class can
provide double-digit returns that rival those in the equity
markets, with significantly less volatility -- and we could be
headed for one of those periods.
Don't Believe Everything You've Heard
Don't make the mistake of thinking all high-yield bonds
are "junk." The reputation of this group was tainted years ago
with the high-profile securities fraud conviction of Michael Milken, who was instrumental in bringing these securities to
prominence as a funding vehicle for hostile corporate takeovers
and leveraged buyouts (LBOs). Because of this, many people
assume high-yield bonds are only issued by shady businesses
committing some sort of crime, but this isn't true.
Fortunately, rating agencies like Moody's (NYSE: MCO) exist to
help sort through the gaggle of bonds available. These companies evaluate
each issuer's creditworthiness through a rigorous examination of
its balance sheet, cash flow visibility and overall financial
stability. The companies that score highest are deemed to be
worthy of "investment grade" status ("Baa" or higher), while those
with a few question marks are assigned
ratings that fall on the lower rungs of the credit quality
ladder.
Additionally, the high-yield bond market has evolved since the
famous scandal and is quite
appealing today, thanks to several factors:
Growing Global Market: According to Dealogic, global
high-yield debt issuance totaled more than a quarter-trillion
dollars in 2007, with volume reaching a record $100 billion in
the second quarter alone. Much of that came from overseas
markets, which now account for roughly half of new high-yield
issues.
Quality Issuers: While it's true that some high-yield
debt really is junk, many companies with below investment-grade
credit ratings are actually on sound financial footing and
generate hefty cash flows. High-yield bond issuers include
venerable firms like General Motors (NYSE: GM), Hilton Hotels and MGM
Mirage (NYSE: MGM). These three companies are just a small sample of the
numerous companies from a variety of industries issuing
high-yield debt.
Not Rate Sensitive: High-yield bonds typically have low
durations and aren't particularly sensitive to interest rate
fluctuations. Much like stocks, high-yield bond returns are
driven more by the overall state of the economy -- which
influences the ability of borrowers to meet their payment
obligations. As a result, these bonds can actually gain ground
in a rising rate environment, while others tend to struggle.
This low correlation makes the high-yield sector a powerful
diversification tool.
Capital Appreciation Potential: High-yield bonds have
delivered average annual returns of nearly +10% over the past
five years -- not all of those gains have come from interest
payments. It's not uncommon for these bonds to trade at steep
discounts to their par value, paving the way for significant gains if the
financial outlooks for the underlying companies show signs of
improvement. For example, Standard & Poor's upgraded 193
high-yield issuers in 2005, boosting the value of more than $200
billion worth of debt.
The Sky is Not Falling
Having said all this, there is still no sugar coating the
biggest risk faced by high-yield bond investors: the dreaded
default. For some reason or another a company may deteriorate and
won't be able to meet certain loan covenants or come up with the cash to
cover its payments. While this risk is certainly real, it is
often overstated and more than compensated for by the extra
yield. In fact, at the end of January default rates
sunk to around 0.9% -- the lowest rate in nearly 30 years.
And according to the Bond Market Association,
the yield spread (or "risk premium") between high-yield bonds
and Treasury securities of comparable maturity has run between
300 and 400 basis points throughout most of the past two
decades.
In other words, if a 10-Year Treasury Bond offered a yield of
4%, then a corresponding high-yield bond might get you a much
juicier payout of 7-8%.
Thanks to the subprime meltdown, investors can now rake in yields more than
600 basis points above the rate on corresponding Treasuries. That is
more than double the 2.7% differential from this past June and
marks the highest interest spread since 2000.
Looking Ahead
Over the past 15 years, the overall credit quality of
corporate America has been trending lower. In 1992, nearly
three-fourths (72%) of all debt issuers were given investment
grade ratings by Standard & Poor's -- today, that percentage
stands at just 50%.
This pronounced shift (which in part has resulted from stock
buybacks and other deliberate actions) presents both
opportunities and challenges. On one hand, it has increased the
supply of high-yield debt, lifted yields and widened spreads.
However, it also means that a recession could see default rates
spike well into the double-digits.
But even that would create opportunity. During the recession of
1990, default rates shot up to nearly 8%. But when conditions
improved the following year, high-yield bonds delivered a
whopping gain of +44% and went on to produce returns north of
+15% in each of the next two years.
Now, I'm not suggesting that exact same scenario will play out
again. But, it's clear that high-yield bonds can be highly
profitable investments when yield spreads have widened and the
economy begins to pick up steam.
We haven't reached that recovery stage just yet, but it's never
too early to begin planning by taking a look at the funds
listed
below. . .
Important Note: In the
remainder of this article,
ETF Authority
editor Nathan Slaughter lists four of the best high-yield bond funds available
on the general market, and provides
extensive profiles on his two favorites. Each one offers
exposure to the potential boom in high-yield debt, and more importantly, each one offers a yield in excess
of 8.0%. However, in order to view the
remainder of this article, you'll need to subscribe to our
premium ETF investing newsletter --
The ETF Authority. After you
subscribe, you'll receive immediate access to this full article,
as well as our monthly
ETF Authority newsletter and a
host of additional premium content. Please visit one of the
following links to continue. . .
Good investing!
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Nathan Slaughter
Editor
The ETF Authority, Half-Priced Stocks
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in-depth guidance on today's leading exchange-traded funds (ETFs), plus
a proprietary ranking system designed to uncover today's most
profitable funds, please subscribe to
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ETF Authority |
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