Spread Your Risk In The Bond Market

by Alan Lavine and Gail Liberman

What's an income investor to do? You can leave your money in money market mutual funds or bank CDs. But you won’t earn enough income. By contrast, if you invest in a higher-yield investment, the risk is greater that you could lose money.

One option to boost the overall yield on your investments is to combine less risky investments with riskier ones. Typically, investors that include high-yield bonds with bank CDs, money funds and Treasury securities, have a higher average yield than they would if they had simply held today’s low-rate CDs and Treasury bonds.

Although the rate is higher, the combined investment is less risky than putting all your eggs into super high-yield bonds. The reason: The investments don’t move in tandem. So when one investment zigs the other zags.

Companies with poor credit ratings issue high-yield bonds. The bonds pay higher yield because there is a greater chance of default compared with bonds rated AAA by Standard & Poor’s.

So how much of your income investments should be invested in a high-yield bond fund? Margie Patel, manager of the Pioneer High Yield Fund, Boston, says most financial advisers suggest putting about 10 percent of your total investments or 20 percent of your fixed income investments into higher-yield bonds.

Patel says the high-yield market offers an attractive alternative to the rest of the bond market's low rates. High-yield bonds are more in line with stocks that bonds. So if the stock market continues to do well, so should high-yield bonds.  

The fund carries a top five-star rating from Morningstar Inc., Chicago. It yields 7.2 percent.

Patel attributes the Pioneer High Yield Fund's rating to the care it takes selecting the financially strongest high-yield bonds. "Industry selection is fundamental," she says. “We look for good companies with strong performance within those industries and concentrate our assets there," she added. "We avoid industries and companies with poor operating records."

Although some financial analysts believe that bond markets have had their run, Patel says that the high-yield market still is attractive and will continue to perform well.  "The economy is growing, the Fed is still supportive, and defaults have dropped off materially," she says.

The top five sectors are technology, non-consumer cyclicals, capital goods, basic industries and real estate. The fund has 62 percent in convertible bonds, 27 percent in high-yield corporate bonds, 6 percent in investment-grade corporate bonds, 3 percent in emerging market and international high-yield bonds and 2 percent in convertible preferred stock.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "The Complete Idiot's Guide to Making Money with Mutual Funds," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show.

More articles by Al and Gail can be found here.