Let’s talk about bonds! Woot!!! I’m sure it’ll get your blood pumping. Ok, maybe not. I considered adding some pictures of fashion models in bikinis to go along with this post, just to liven it up. (Don’t scroll down, I didn’t.) Let’s get down to it. Why bonds?
First of all, I’m not big on diversification. I certainly don’t want too much money in one stock, but I have no problem having a lot of exposure to one sector. As I write this, I have 37% of my money in energy companies of one type or another, and that’s if you include my cash position, which is about half of my portfolio. So I’m certainly not concerned about asset class diversification. If I had my entire portfolio in individual stocks, the only concern I’d have is that I wouldn’t have money to buy more.
But did you know that you can buy exchange traded funds that invest in bonds? I just found that out recently. I knew there were ETFs out there for just about everything. There’s even a few that track livestock. So of course there are ETFs for bonds. But why would I, a stock picking guy, want in? Yield, of course. And, for me, an ETF has certain advantages. First, I can buy and sell them in my regular accounts, the way I’m familiar with. Second, and probably more important, is diversification. Ok, that contradicts what I said above, but hear me out.
If I want yield in bonds, what do I need to invest in? Junk bonds, of course! And junk bonds are risky, right? The ratings companies say the ‘paper’ isn’t ‘investment grade’ or whatever, so there is default risk, hence higher yield. So if I go out and buy a single junk bond, never having bought a bond before and not really knowing what I’m doing, and the company decides not to pay, I’m screwed. I just picked one of the ETFs I’m considering at random and looked: 996 holdings. So if a few default, not the end of the world, right?
Currently the ETFs I’m looking at are yielding around 5.5% to 7.5%. Nice, but not particularly impressive, especially compared to some of the stocks I’m in. Nope, that isn’t going to do it. But what if these funds start to tank? What about the rate hikes that people are talking about? Rate hikes hurt bond prices, though from what I’m reading they don’t effect junk bond prices as much. But I think the real threat to the ETF share prices might be from some severe economic weakness, real or perceived.
As I vaguely started to allude to in my recent piece on Intel (NASDAQ: INTC), I’m looking to start a ‘Financial Doomsday’ shopping list. There will come a time when confidence in the financial system and the economy drops off a cliff. The markets will tank, and some people will scream that they won’t come back for a long, long time. It may not happen this year, or the next, but if history is any indication, it WILL happen. Bond ETFs will just be another tool on my Financial Doomsday shopping list. At 6% yield I’m not that interested. But 12%? 15? More? It could happen. It might not, but if it does, I want to be prepared.
The first one I’m looking at is iShares iBoxx $ High Yield Corporate Bond (NYSEArca: HYG). This ETF has over $17 billion of net assets, and a yield of about 5.8%, and an expense ratio of 0.5%. The largest sector of its holdings is communications, at about 25%, with several recognizable names. Their energy exposure is around 10% of their holdings. Nearly half of their holdings are BB rated, with most of the rest B rated. Only about 11% of their holdings are CCC rated, with almost noting below that. So not terrible. Slightly over half of their loans reach maturity in 3 to 7 years.
SPDR Barclays High Yield Bond (NYSEArca: JNK) is similar to HYG, currently yields about 6.3%, but its holdings have a slightly worse mix of ratings, and the fund has at expense ratio of 0.4%.
SPDR Barclays Short Term Hi Yld Bd ETF (NYSEArca: JNK) is smaller, with only around $3 billion of assets under management. It currently yields around 5.5%, and has an expense ratio of 0.4%. This fund has shorter term bonds, with most maturing in 3 to 5 years.
Market Vectors EM High Yield Bd ETF (NYSEArca: HYEM) is all about emerging markets junk bonds. Hong Kong, Brazil, Argentina, Mexico, Ukraine, Jamaica, South Africa, Thailand, Croatia, Spain… you get the idea. Perhaps not for the faint of heart? I’ve never felt the need to invest in any of these countries, but for enough yield? Maybe. Currently it’s yielding about 7.3%. I’m not touching it for that. This fund has an expense ratio of 0.4%, and only about $245 million assets under management. This would have to yield way more than the others for me to become interested.
So these are the 4 I’ve put on my radar, but there are a bunch more. There are ETFs that track municipal bonds, investment grade bonds, and others categories, but this is what I’m looking at now. If anyone is interested in these, I would certainly encourage them to do some research. Look at fact sheets, holdings, and prospectuses. This is fairly complex stuff that I’m just starting to look into myself.
As always, feel free to look at my portfolio and see how I’m doing. Usually I own or plan to own stock in many of the companies I write about. Please READ MY DISCLIAMER. Make your own decisions, do your own research, and never rely on any single source for information. I am not a financial professional; do not rely on me as such.
Michael, the Stock Picking Bartender,