Stock Market: Why High-Yield Bond Funds Are at Risk
The high-yield bond sector is down 10.43 per cent for the year and there may be more losses to come. Photo: AbsolutVision/Pixabay
There’s been turmoil in the corporate bond market, but the FTSE Canadian Universe Bond Index is still up just over two per cent for the year (as of April 3). That’s not a lot but it looks terrific when compared to the Toronto Stock Exchange.
But there’s one area of the bond market that’s suffering badly: High-yield bonds. That sector is down 10.43 per cent for the year and there may be more losses to come.
The reason is simple. The deeper this recession goes and the longer it continues, it is likely we are going to see an increasing number of corporate defaults, despite the government’s bail-out plans. If that happens, bond holders may end up receiving pennies on the dollar, or even nothing at all.
High-yield is really just a polite term for junk bonds. They’re issued by companies with weak credit ratings, which means they are below investment grade. The attraction is a high interest rate.
When economic conditions are good, as they were until the virus hit, investors don’t worry a lot about credit rating because the risk of default was low. But the virus, and the economic toll it is taking, is a game changer. Now there’s a real risk some of these marginal companies will go under, dragging their bonds down with them.
Let’s look at the Phillips, Hager and North High Yield Bond Fund as an example. We originally recommended it in my Income Investor newsletter at $10.87 in June 2003 and it has been a dependable performer over all the years since. For the decade to the end of February, the average annual compound rate of return was a very respectable 5.87 per cent. That was well above the category average of 4.75 per cent.
But in March, the fund’s net asset value dropped by eight per cent, a huge one-month decline for a bond fund of any type. The 10-year average annual compound rate of return was reduced to 4.9 per cent as a result.
In 2019, the fund distributed $0.50 per unit, the lowest payout in the past decade. If it were to replicate that amount this year, the yield at the current price would be 4.8 per cent. But there’s no guarantee of that – the annual distributions have been declining since 2017.
This has always been a dependable fund and the management team is first-rate. But it is not the right fund for these rapidly changing times. I have reluctantly advised my readers to sell. I also suggest that you review your portfolio and sell any other high-yield bond funds you may be holding. Their time will come again, but it could be a long wait.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.
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