bonds

Earn Income of Up to 8% From High-Yield Bonds

With defaults rising, reaching for these returns means serving yourself a big portion of risk.

Issued by firms with below-average credit ratings, these bonds pay much more than investment-grade IOUs. The average “junk” bond now yields 8.4%, according to Merrill Lynch, up from about 5% in mid 2014. Today’s plump yields should help the bonds retain more value should interest rates rise.

Earnings for All

Risks to your money. Defaults are rising, led by the energy, metals and mining industries. Ratings agency Fitch predicts that high-yield bonds will default at a rate of 6% in 2016, up from 3.5% in 2015. Although that’s well below peak rates of about 10% in a typical market cycle, making money gets harder when defaults are escalating, says Marty Fridson, a veteran high-yield analyst. Moreover, outside of commodity-related bonds, junk looks to be “fairly or richly valued,” he says.

Hire a pro. Treading cautiously makes sense in this environment. Osterweis Strategic Income (OSTIX, 7.6%) has held up relatively well in past downturns and should continue to limit losses if the high-yield market stumbles. Lead manager Carl Kaufman looks for businesses he believes are improving and are candidates for a ratings upgrade. Such discipline keeps him far away from the energy patch. (All prices and returns are as of March 31.)

Vanguard High Yield Corporate (VWEHX, 5.6%), a member of the Kiplinger 25, sticks with debt in rating tiers just below investment grade. Its conservative stance should make it a better bet in a junk slump. For more income, go for iShares 0-5 Year High Yield Corporate Bond ETF (SHYG, $45, 6.6%). It owns bonds maturing in less than five years, limiting its interest-rate risk. Energy-related bonds make up nearly 9% of its assets. That could hurt results if the rally in oil prices falters.

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