By Stoyan Bojinov
(ETF Database) Equity markets have gotten off to a solid start in the new year, although looming Euro zone debt woes continue to breed some degree of pessimism and one piece of bad news from overseas is very well capable of sparking a broad sell-off that spills over onto Wall Street.
The tug of war between positive economic data releases on the home front and turmoil in Europe continues, paving the way for volatile trading across asset classes as investors struggle to decipher which way the markets will tip next. Amidst the ongoing uncertainty, many investors are gravitating towards dividend-paying securities, particularly in the fixed-income corner of the market, in an effort to favorably position themselves as the global financial drama develops in 2012.
High-yield bonds, commonly referred to as "junk bonds", have taken on great appeal amongst investors looking to beef up their portfolios' current return and further diversify their bond component.
With government debt woes still plaguing confidence in the markets and expectations for interest rates to remain low in the foreseeable future, it's not much of a surprise to see investors opting for dividend-paying securities in the bond space in lieu of chasing after lucrative stock market returns.
High Hopes For "Junk" Debt
Despite the rather unappealing "junk bond" label, high-yield corporate debt may be one of the few bright spots in 2012 for those looking to enhance their current return without taking on considerable risk. While U.S. Treasuries are undoubtedly one of the "safest" segments of the bond market, their rock-bottom yields leave much to be desired [see International Bond ETFs: Cruising Through All The Options].
Furthermore, government bonds may come under pressure over the coming year if economic conditions at home continue to improve, which would in turn prompt investors to reallocate capital to more attractive corners of the market.
Investing in high-yield bond segment may appeal to investors for a variety of reasons--first and foremost, the underlying fundamentals of this asset class suggest that the inherent risks are significantly fewer than many might expect.
According to Fitch Ratings, the default rate for U.S. companies in the high-yield universe is expected to be around 2.5% to 3%, well below the historical long-term average annual rate of 5.1%. Relatively lower rates of default translates into a more attractive risk/return profile for junk bond investors.
Another compelling piece of evidence from J.P. Morgan is the fact that high-yield issuers are becoming more and more profitable, and leverage in the space has been broadly, and steadily decreasing since peaking in late 2009. Additionally, improving economic conditions coupled with robust corporate earnings (and record levels of cash on hand) are two key factors that may further reduce the risks associated with high-yield debt notes.
Compelling fundamental improvements in the junk-bond space make this space difficult to ignore given the juicy dividends that are sure to impress even the most yield-hungry investors.