After a five-year slump that lasted through last October, junk bonds have been on a tear over the past six months. But they havent worn out their welcome with investment professionals yet.
"Technically, people would say after such a long run, there is bound to be a pullback," said Erika Safran, a financial planner with Financial Asset Management Corp. "But there are few other investment vehicles out there that provide this kind of yield right now. Over the long term, people are not buying equities," she said.
One of the biggest draws to high-yield bonds is their spread over treasuries. While the average yield on junk bonds has fallen since the beginning of the year Standard & Poors speculative-grade credit spread is down to 693 basis points from around 1,011 in January its still very attractive relative to other asset classes. With the 10-year Treasury yielding about 4%, junk bonds can pay as much as 11%. By comparison, Standard & Poors investment grade spread is at 163 basis points. That translates to a payout of just under 6% on investment-grade corporate debt. The broad S&P 500 equity index, meanwhile, is down close to 2% since the start of 2003.
Michael Boone, a CFP at MWBoone & Associates in Bellevue, Wash., said hes been recommending junk bonds since the end of 2001 and that he will continue to do so until the yield spread with Treasuries falls to around 2%. "At that level, youre not getting paid for the risk youre taking," he said.
In the meantime, default rates on high-yield bonds continue to come down, something that tends to happen as the economy improves. The 12-month-trailing speculative default rate is just over 6.5%, down from a high of over 10% during the past year, said Diane Vazza, a managing director at Standard & Poors. "We expect it to remain high by historical standards, but decline slowly by year-end," she said.
Boone said he recommends growth investors allocate as much as 20% of their portfolios to high-yield bonds.
"It is still a good time for these instruments, but certainly you should be diversifying your risk," Vazza said. "While the default rate is coming down, its still high by historical standards, so we're still in a credit-intensive environment. You still need to do your homework."