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Junk Bond Funds
Old 06-21-2010, 06:09 PM   #1
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Junk Bond Funds

A junk bond fund I was looking at has a yield of around 8%. I believe that historically for a BB fund you will have around 2% defaults a year and from those a recovery of 40% of principal is the average. So, if one were to be overly pessimistic you could take 2% off the yield to account for defaults (assume zero principal recovered on a default).

Now to account for inflation you could subtract that also. So, lets just say 3% inflation. So that leaves you with 3% real return. That seems pretty good to me given all the uncertainty, provided you have space for it in an IRA.

What am I missing?
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Old 06-21-2010, 06:58 PM   #2
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Dunno. I am happy holdin moderately junky stuff. Just make sure you pay attention to the yield and be prepared to jettison the fund when the spread gets too tight to really offer compensation for the risks.
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Old 06-21-2010, 07:41 PM   #3
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Originally Posted by brewer12345 View Post
Dunno. I am happy holdin moderately junky stuff. Just make sure you pay attention to the yield and be prepared to jettison the fund when the spread gets too tight to really offer compensation for the risks.
Thanks Brewer. Does my real yield approximation sound reasonable?
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Old 06-21-2010, 07:49 PM   #4
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I have a 10% allocation to HYG, which I bought around $70.

Think I'll keep taking the monthly payment for now...
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Old 06-21-2010, 08:05 PM   #5
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Thanks Brewer. Does my real yield approximation sound reasonable?

More or less. But be aware you have more risk than treasuries and HY is prone to periods of both excessive over and undervaluation. I would say that considering the outlook HY is moderately cheap, but not at an extreme by any stretch.
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Old 06-28-2010, 06:10 PM   #6
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Watch out there is a tremendous amount of risk that comes with this..
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Old 06-28-2010, 07:08 PM   #7
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I got out of my Vanguard Junk Bond fund at the beginning of the year. One thing that is worth looking at is the history of distributions of a junk bond fund. In the case of Vanguard (and I assume others) they have decline dramatically as the cumulative effect of defaults take their toll.

I went through a similar calculation 1-2% default 3% inflation when the yields were north of 10% and said it was worth the risk back in Dec 2008. (Brewer knowing more than myself was buying individual junk bonds in the same time frame, and am sure did well)
It is certainly less attractive now than then but of course everything look less attractive now days.

Someone suggested treating junk bonds as 1/2 equity 1/2 bond as far as Asset Allocation goes and that seems very sensible to me. The fund will do fine in a slow recovery, and will be hurt in a double dip.
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Old 06-28-2010, 08:25 PM   #8
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I have posted about bond funds which invest in bonds below investment grade (BBB). Do you consider anything below BBB to be "junk" or do you think it is better to consider bond funds which invest mainly in bonds which are rated C, D, or not rated to be junk bond funds, with those slightly below investment grade (BB, B) to be simply "slightly below investment grade?"
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Old 06-28-2010, 09:57 PM   #9
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I have posted about bond funds which invest in bonds below investment grade (BBB). Do you consider anything below BBB to be "junk" or do you think it is better to consider bond funds which invest mainly in bonds which are rated C, D, or not rated to be junk bond funds, with those slightly below investment grade (BB, B) to be simply "slightly below investment grade?"
Probably the latter. The fund is the vanguard one mentioned in the thread already. It is rated BB over all. I compared it to the fidelity fund that you use and they are pretty similar. If I remember right the fidelity fund was slightly higher quality, with more BB bonds and less B bonds than the vanguard fund.

Here is the fund:

Vanguard High-Yield Corporate Report (VWEHX) | Asset Allocation Summary
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Old 06-29-2010, 05:56 AM   #10
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Not all junk is created equal. There is a big difference between a CCC and a BB credit. Unfortunately, the risk reward trade-off changes dramatically over time, so we cannot just say that a particular grade of junk is always the best choice. Having said that, the higher the rating, the smoother the ride. So a fund like VG that holds mostly BB rated credits will be a lot less "exciting" than one that deals in really junky stuff. Sometimes you get enough extra yield to compensate for the defaults in CCC stuff and sometimes you do not.

If you believe it will take an extended period for us to get back to full employment, junk will prob outperform equities, especially if the credit markets continue to behave reasonably.

I hold some junk, but have not gone overboard. I own a B rated bond, one with "5 Bs" (BBB/BB split rated), some FTF (one third each agency MBS, junk, and junk bank loans), and JQC (mostly BB rated bonds and preferreds, some converts). Junk isn't crazy cheap, but corporate credit trends have improved and balance sheets are in vastly better shape than a couple years ago. Given all that and the paucity of yoelds elsewhere, I think a dollop of junk can be a reasonable addition to one's portfolio. But you should not expect it to behave like treasuries because it isn't.
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Old 06-29-2010, 06:08 AM   #11
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Not all junk is created equal.
So size really does matter?
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Old 06-29-2010, 06:16 AM   #12
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Probably the latter. The fund is the vanguard one mentioned in the thread already. It is rated BB over all. I compared it to the fidelity fund that you use and they are pretty similar. If I remember right the fidelity fund was slightly higher quality, with more BB bonds and less B bonds than the vanguard fund.

Here is the fund:

Vanguard High-Yield Corporate Report (VWEHX) | Asset Allocation Summary
Yes, the Fidelity fund (Focused High Income) has more BB and less B rated bonds than the Vanguard one. But the Vanguard fund, around since 1978 compared to Fidelity's being around since 2004, had an expense ratio about 0.50% higher than Vanguard's.
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Old 06-29-2010, 07:47 AM   #13
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If you believe it will take an extended period for us to get back to full employment, junk will prob outperform equities, especially if the credit markets continue to behave reasonably.
Based off the last unemployment data this is what I'm expecting.

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Junk isn't crazy cheap, but corporate credit trends have improved and balance sheets are in vastly better shape than a couple years ago. Given all that and the paucity of yields elsewhere, I think a dollop of junk can be a reasonable addition to one's portfolio. But you should not expect it to behave like treasuries because it isn't.
This is also why I was looking at VWEHX. I don't think the risk is anything like it was before, but the yields are still reasonably close to what they were.

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Yes, the Fidelity fund (Focused High Income) has more BB and less B rated bonds than the Vanguard one. But the Vanguard fund, around since 1978 compared to Fidelity's being around since 2004, had an expense ratio about 0.50% higher than Vanguard's.
I noticed that and I think it helps offset the risk a little bit in comparison. There are also admiral shares with the vanguard fund that could lower the expense ratio down to .15%, which is crazy low.
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Old 06-29-2010, 09:13 AM   #14
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If you believe it will take an extended period for us to get back to full employment, junk will prob outperform equities, especially if the credit markets continue to behave reasonably.
I suspect that as long as default rates don't start spiking and the economy doesn't start falling off a cliff again, there's enough money out there which is absolutely desperate for yield -- any yield -- to keep junk prices fairly strong.
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Old 06-29-2010, 09:57 AM   #15
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I am sure this is old hat to most, but here is a comparison of Vanguard's Total Bond, TIPs, and High Yield funds 10 year performance.
vanguard bond funds.gif
It seems to me that Total Bond is the least volatile, High Yield the most. The TIPs fund came out ahead in this period, despite a nasty dip during the panic.
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Old 06-29-2010, 03:55 PM   #16
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I am sure this is old hat to most, but here is a comparison of Vanguard's Total Bond, TIPs, and High Yield funds 10 year performance.
Attachment 9566
It seems to me that Total Bond is the least volatile, High Yield the most. The TIPs fund came out ahead in this period, despite a nasty dip during the panic.
Gee I timed my trip in and out of VWEHX pretty well. I wish I could be so bloody lucky skillful in all of my market moves.
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Old 06-30-2010, 09:41 PM   #17
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So size really does matter?
If your talking about "junk in the trunk" then its debatable.
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