Sometimes it's hard to pinpoint just where things started going wrong. Maybe it was the beers at the Hoot 'n' Holler. Maybe it was the game of
In any case, here you are, waiting for a lawyer and making small talk with a guy named Knuckles.
In finance, as in life, disaster doesn't always strike suddenly. There are usually warnings beforehand. And while predicting markets is dangerous, there really are very few happy outcomes from junk bond funds right now.
Most of the time, junk bond funds don't present huge problems to investors. Most people repay their debts; so do most corporations. The high yields from a diversified portfolio of junk bonds can overcome the occasional default.
Every so often, corporate lenders undergo a kind of mania that's not different from manias in stocks, baseball cards or tulips. And while crying, "Bubble!" has been a cottage industry for pundits, you can argue that high yield is starting to look, well, bubbly.
A bubble doesn't just mean that prices seem weirdly high. Anyone who remembers when the Dow Jones industrial average broke through 2000 blinks when he sees the Dow nudging up against 17,000.
But corporate earnings have grown enough since
In the case of high-yield bonds, prices are at an all-time high. One way to measure a bond's price is its yield -- and, in the upside-down world of bonds, the lower the yield, the higher the price. This week, Barclays Capital High-Yield Index yielded 4.83%, the lowest in history.
Yields are low compared with other bonds, too, says
One of the hallmarks of a bubble is that new, even riskier investments start to appear. For example, in the 2007 bubble, investors bought packages of shaky mortgages to goose up their yields. Nowadays, investors are buying packages of shaky auto loans.
And, of course, when the demand for anything is brisk,
"There were five deals priced (Wednesday), and they were all oversubscribed," says
At the same time, the number of rating downgrades for junk bonds is outpacing the number of upgrades. "You have to use more caution and credit selection than you did before," says Hozef Arif, portfolio manager at
When you're at record low yields, there's nothing to say that yields won't go lower. If the economy improves, so should the finances of the companies that issue junk bonds.
But at these levels, "the odds are against you," Lonski says. Junk could get hit in two ways. A rise in rates would hurt bond prices in general. And an increase in defaults could hurt junk, too.
"Your expectations should be that earning your interest is as good as it gets," says
You can mitigate your interest rate risk, to some extent, by investing in funds that buy short-term junk bonds. Typically, short-term bonds aren't hurt as badly as long-term bonds when interest rates rise. Schmidt recommends exchange-traded funds that buy short-term junk. One example:
If you've owned a junk fund for a long time, consider paring back and distributing the proceeds to other parts of your portfolio.
For example, if you originally had 10% of your holdings in junk bonds and you now have 20% there, think about selling enough to get you back to 10%, particularly if you're in a tax-deferred retirement fund, such as an IRA.
But if you're thinking of buying a junk bond fund, you should probably think again. You don't want to find yourself staring at a hole in your portfolio and wondering how on Earth it got there.
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