Make Money in Junk Bonds -- the Easy Way
Nov 13th 2012 5:01PM
Updated Nov 13th 2012 5:06PM
Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some high-yield, or "junk," bonds to your portfolio, the PowerShares Fundamental High Yield Corporate Bond ETF (NYS: PHB) could save you a lot of trouble. Instead of trying to figure out which companies will perform best, you can use this ETF to invest in lots of them simultaneously.
ETFs often sport lower expense ratios than their mutual fund cousins. The PowerShares ETF's expense ratio -- its annual fee -- is a relatively low 0.50%. Its 12-month yield is about 5.11%.
The ETF has performed rather well, beating its benchmark over the past three years. As with most investments, of course, we can't expect outstanding performances in every quarter or year. Investors with conviction need to wait for their holdings to deliver.
With a low turnover rate of 25%, this fund isn't frantically and frequently rejiggering its holdings, as many funds do.
Why junk bonds?
The appeal of junk bonds is that, as they're issued by companies in relatively shaky condition, the companies have to offer generous interest rates in order to compensate for their risk. The risk of default is very much there, which is why they're commonly referred to as junk bonds.
It's instructive to peer into the holdings of an ETF like this for several reasons. As a would-be investor in the ETF, you should know what kinds of holdings it has. Its components also serve to remind us about which companies have been struggling and have raised money by lending at relatively high rates. Since the ETF's managers are aiming to not lose money on the bonds they choose, they're effectively delivering a vote of confidence to their components' issuers.
Clothing retailer GAP (NYS: GPS) , with a coupon rate of 5.95% and a yield to maturity of 6.53%, has been struggling. Its revenue and earnings have been having trouble growing, though its shrinking share count has helped boost earnings per share (EPS). Debt has just surged recently, but so has free cash flow. The stock is up about 70% over the past year, and has averaged 11% annual gains over the past 20 years. The jury is still out on whether Gap's turnaround is under way.
Timber REIT Weyerhaeuser (NYS: WY) , with a coupon rate of 7.38% and a yield to maturity of 5.17%, posted mixed quarterly results last month, but is positioned well to benefit from a recovering housing market. It has lower debt than many peers, but is viewed as overvalued by some. It's involved in a range of operations, from real estate to homebuilding to timberlands to packaging, and more.
Rite Aid (NYS: RAD) , with a coupon rate of 8.00% and a yield to maturity of 6.42%, has been struggling for quite a while. Its stock is down more than 20% over the past year, and has averaged annual losses of more than 20% over the past five years. The pharmacy chain got a temporary boost earlier this year, when a spat between Walgreen (NYS: WAG) and Express Scripts (NAS: ESRX) sent many customers to CVS (NYS: CVS) or Rite-Aid. There are signs of hope for the company, as its losses have been narrowing recently; but, still, revenue hasn't been growing, and it's a risky bet.
Regions Financial (NYS: RF) , a bank with a coupon rate of 7.75% and a yield to maturity of 7.75%, looks rather attractive on many counts, having repaid its TARP obligation, posting improving financial numbers, and showing a powerful presence in the growing Southeast region. Some think that, given its recent run-up, though, it's no longer quite a bargain. My colleague Sean Williams, though, has nominated the company's leader for CEO of the year.
The big picture
A well-chosen ETF can grant you instant diversification across any industry or group of companies -- and make investing in and profiting from it that much easier.
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The article Make Money in Junk Bonds -- the Easy Way originally appeared on Fool.com.Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, has no positions in the stocks mentioned above. The Motley Fool owns shares of Express Scripts and Weyerhaeuser Company. Motley Fool newsletter services recommend Express Scripts and Gap. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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