Generally, I am not interested in bonds in this market environment. Interest rates are simply too low to justify the risk of holding them. Nevertheless, I think there are exceptions to this rule, and while I wouldn’t devote a large portion of my portfolio to bonds, there is a place in any portfolio for bonds that generate a high, steady rate of return.
First, investors should consider owning some high yield bonds, and I like the Pertius High Yield Bond Fund (NYSEARCA:HYLD) as opposed to the more popular iShares High Yield Bond Fund (NYSEARCA:HYG) and the SPDR Barclays High Yield Bond Fund (JNK). Since HYLD is much smaller than its peers, its managers can invest in the bonds of smaller companies that large bond fund managers overlook, consequently achieving a higher yield.
While HYLD’s high yield is reduced due to an admittedly outsized 1.35 percent expense ratio (JNK has an expense ratio of 0.4 percent, HYG’s expense ratio is 0.5 percent), it manages to exceed 7.5 percent after expenses, which beats JNK and HYG by roughly 150 basis points. Furthermore, HYLD has a shorter average duration than JNK or HYG, which implicitly means that it has less risk; HYLD has a duration of just 2.66 years, whereas JNK and HYG have durations closer to 4 years.
HYLD also has the advantage of being actively managed, so that if some issues held by the fund run up in value, the managers can sell them and purchase other assets. HYG and JNK both track indexes, which means that the manager cannot sell any particular bond just because s/he believes that it is overvalued, and with all asset indexes the biggest holdings are the assets that have run up the most in value, making them inherently unappealing from a value perspective.
Second, investors should consider a contrarian bet in emerging markets debt, and the ETF for this would be the WisdomTree Emerging Market Local Debt Fund (NYSEARCA:ELD). Emerging markets have been featured on the front pages as extremely risky as of late. However, many of the countries featured in this fund such as Russia, South Korea, or Malaysia all have relatively conservative fiscal policies, reasonable benchmark interest rates (as opposed to 0.25 percent from the Federal Reserve), and relatively low debt to GDP ratios. Thus, I think the ongoing volatility and headline risk coming from emerging markets is creating an opportunity in funds such as ELD. Over the past year, the fund is down over 15 percent in value, and so now might be a good time to enter this fund while most investors are fleeing. The fund has an effective 3.5 percent yield, which isn’t that high, although it beats Treasuries and CDs. It has an expense ratio of 0.55 percent and it has a duration of roughly 4 years.
Ultimately, there aren’t many great opportunities in the bond market given the low interest rate environment. However, bonds are appropriate in virtually every portfolio.