Bond funds: Opposites that attract higher yields

Fri Dec 2, 2011 5:00pm EST

Related Topics

Dec 2 (Reuters) - With the Federal Reserve keeping rates low and casting a cautious eye on Europe, is there still a way for investors to achieve higher yields?

There are many options -- from municipals to A-rated corporate bonds to emerging market bonds. Sometimes funds that are at opposite ends of the risk spectrum can add to your portfolio diversification while boosting yield. Two often overlooked choices are, Ginnie Maes and high-yield corporate bonds.

While they're dissimilar when it comes to default risk, they could both be paired up in a diversified income portfolio to achieve returns above U.S. Treasuries and money-market accounts.

Ginnie Maes are mortgage-backed securities -- but not the kind that plummeted in value during the 2008 meltdown. That's because they are backed by the Government National Mortgage Association, a full-fledged U.S. agency that has the full faith and credit of the U.S. government.

They provide an even safer yield than the securities issued by Freddie Mac and Fannie Mae, which have an implied guarantee from the government, but are part of agencies that were publicly-traded prior to their takeover by the government during the housing collapse.

On the other end of the spectrum are high-yield bonds, which are corporate bonds with relatively low credit ratings, meaning they are more likely to feel the impact of defaults than other fixed income securities. They are not government guaranteed and carry more risk, hence their nickname "junk" bonds.

BOND FUNDS SPREAD OUT RISK

In either category, bond funds are the best vehicle for most investors to build income in. Funds give investors the benefit of the highly diversified holdings. They also spread around the risk of any single bond going bad.

Safe as they are, even Ginnie Mae issues could be hit by a rash of early payments on mortgages if homeowners pay off loans early, especially as mortgage rates fall and they refinance.

On the other end of the spectrum, high-yield bonds are so sensitive to repayment risk their value can fall quickly if the economy turns sour and companies start having trouble repaying bond holders.

In addition to providing diversity, funds with professional managers constantly monitor their portfolios for trouble spots and make adjustments.

Here are some good candidates:

-- One of the best ways to buy high-yield corporate bonds is through ETFs such as the SPDR Barclays Capital High Yield Bond ETF (JNK.P) or the iShares iBoxx $ High Yield Corporate Bond Fund (HYG.P). The SPDR fund is yielding 8 percent and the I-Shares fund yields 7.7 percent.

-- The largest Ginnie Mae funds include Vanguard GNMA (VFIIX.O), Fidelity GNMA (FGMNX.O) and T Rowe Price GNMA (PRGMX.O). What's a typical return for these funds? The Vanguard fund, for example, had a 6 percent total return over the past year (through Dec. 1), according to Lipper, a Thomson Reuters company. Considering that you get barely a 1 percent yield on an insured money market fund, that's pretty robust. Ginnie Maes usually pay a 1-percent to 1.5-percentage point yield advantage over Treasury securities of comparable maturities.

Neither bond fund is a substitute for cash, such as a federally-insured money-market account or certificate of deposit. They only make sense as part of a diversified income portfolio that also holds Treasury bonds, Treasury Inflation-Protected Securities (TIPS), highly-rated corporate and municipal bonds, insured vehicles and emerging market bonds.

As with all bond funds, these investments are subject to interest-rate risk. Since the Fed has stated it won't raise interest rates until 2013, that gives you a window of opportunity. Should interest rates rise, bond values will fall, so always consider the kind of downside risk you can afford to stomach before investing.

---

The author is a Reuters columnist. The opinions expressed are his own. (Editing by Beth Gladstone and Richard Satran)

FILED UNDER:
Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.