Kip 25

Vanguard High-Yield Corporate Delivers the Cash

It favors the highest-quality junk bonds, which fared much better over the past year than lower-quality debt.

The bond market was “utter chaos” during the sell-off early this year, says Michael Hong, manager of Vanguard High-Yield Corporate (VWEHX) fund, a member of the Kiplinger 25 or our list of favorite low-fee mutual funds. Prices cratered over eight trading days, and liquidity—the ability to buy or sell securities at efficient prices—dried up.  “This was as challenging a market as I’ve ever lived through,” says Hong, who joined Wellington Management, the fund’s sub­adviser, in 1997.

But Hong found order amid the madness. Over the past 12 months, he steered High-Yield Cor­porate, which invests in bonds with below-investment-grade credit ratings (double-B to triple-C), to a 4.0% return, outpacing 69% of high-yield bond funds and the ICE BofA US High Yield index. Hong typically favors the highest-quality junk bonds (debt rated double-B), which fared much better over the past year than lower-quality debt. The fund holds nearly 55% of its assets in double-B-rated debt; the typical high-yield fund holds 38%.

Hong was on the defensive when the year began. In late 2019, he saw signs of weakness in the economy—downgrades in company credit ratings were outstripping upgrades, for instance—and he bolstered the fund with short-term junk bonds and debt that had recently been upgraded to investment grade. Such bonds tend to suffer less than other IOUs  when the market cracks, and they’re easier to unload in a market crisis than traditional high-yield debt. The fund typically holds 6% of assets in cash and Treasuries, so all told, it held 12% of assets in securities that could be quickly converted to cash heading into March.

These days, Hong is focused on companies benefiting from COVID-related trends that may be long-lasting. Homebuilders, he says, are gaining from what may be a permanent shift to suburban life. Movie theaters, on the other hand, are “long-term secular losers,” he says. “It’s all about credit selection here. We want to keep the risk profile on the conservative side.”

Hong’s keen eye on risk has helped the fund consistently deliver above-average returns with below-average risk. Over the past decade, the fund’s 6.1% annualized return beat 85% of its peers. The fund yields 3.9%.

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