investing

4 Great Mutual Funds to Earn 3% to 6% in High-Yield Bonds

A sense that the economic good times can't run on forever has pushed up yields.

Income-hungry investors have long favored high-yield "junk" bonds for the most speculative chunk of their portfolios. Junk securities are any bonds issued by below-investment-grade companies. Because they pose a greater risk of default than high-quality bonds, junk issues must yield more to attract buyers. Lately, junk yields have been pushed higher as investors weigh risk against reward in an aging economic cycle. The average junk-bond yield has risen from a low of 5.4% in 2017 to 6.1% recently, compared with the 3%-to-4% yields of high-quality bonds.

The risks: History shows that many investors flee junk bonds when a recession hits, and bond prices can temporarily collapse. Some junk funds lost more than half of their value in the recession of 2007-09 before rebounding.

But over the long haul, the bonds' high yields have more than compensated for issuers that go bust. Over the past 15 years, the average junk bond fund has returned an annualized 6.9% in interest and principal gains, compared with 3.9% for an index of high-quality U.S. bonds.

How to invest: If you're worried that the economy will get rocky, stick with a fund that focuses on higher-quality junk bonds. A fund that fits the bill is Vanguard High Yield Corporate (VWEHX, 5.4%), a Kip 25 member. Over the past 10 years, the fund has gained 6.7% a year, on average, compared with 6.5% for the average junk fund. Its current duration is 4.2. Another long-term winner: Fidelity High Income (SPHIX, 5.8%), a fund known for its adept bargain-hunting under manager Fred Hoff. Its 10-year average annual gain is 7.3%, and the current duration is 3.6.

Loomis Sayles Bond Fund (LSBRX, 3.3%) isn't technically a junk-bond fund, but longtime manager Dan Fuss has excelled as a bond picker, particularly in high-yield issues. The fund recently had 30% of its $13 billion in assets in junk bonds. Overall, Fuss is very cautious: He had 33% of assets in cash, the highest percentage ever, and the fund's duration of 3.3 is the lowest ever. Fuss fears that the economy and markets could be at a turning point, especially if a trade war takes hold. Until the risks are clearer, he says, it makes sense to keep a reserve of dry powder.

With the Fed pushing short-term rates higher, floating-rate bank loan funds are worth a look. These funds buy short-term loans that are mostly rated below investment-grade and carry interest rates that adjust higher with market rates. We prefer Fidelity Floating Rate High Income (FFRHX, 3.6%), which takes a cautious approach and skews toward higher-quality debt.

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