Yield-starved investors have taken note. During the past year, investors put $18.9 billion into high-yield funds, a big inflow for a category that only has $220 billion in total assets, according to Morningstar.
Make no mistake, high-yield bonds come with more risk than investment-grade issues. During the downturn of 2008, high-yield funds lost 26.4%, while intermediate bond funds -- which focus on investment grade securities -- dropped 4.7%.
But over long periods, the extra risk of junk bonds has been worthwhile. During the past decade, high-yield funds returned 7.6% annually, outdoing intermediate-term funds by more than 2 percentage points.
Although they are riskier than intermediate bonds, junk securities are less volatile than stocks.So high-yield funds can make sensible additions for investors who are wary of suffering big stock-market losses, says Kevin Loome, portfolio manager of Delaware High-Yield Opportunities (DHOAX). High-yield bonds outdid stocks by a wide margin in 2008 and during the downturn that occurred after the Internet bubble burst in 2000. "High-yield can be a good choice for people who want decent returns but can't accept the risk of equities," Loome says. For a relatively cautious fund, consider TIAA-CREF High-Yield (TIYRX), which returned 7.7% annually during the past five years and outdid 92% of peers. The fund emphasizes the higher-quality names in the junk universe. TIAA-CREF has 51% of its assets in bonds rated BB, the top rating for high-yield bonds. In contrast, the average fund in the category only has 28% in BB. Although TIAA-CREF has 3% of assets in bonds rated less than B -- near the bottom of the credit rankings -- the average fund has 14% of assets in the lowest category. The higher quality helped TIAA-CREF excel during the downturn of 2008. For the year, the fund outdid 88% of peers. Another relatively tame choice is Vanguard High-Yield Corporate (VWEHX). The fund returned 6.5% annually during the past five years, outdoing 62% of peers. Vanguard has 50% of its assets in BB bonds and 6% in bonds that are rated BBB, the lowest investment-grade ranking. The fund often lags competitors in rallies, but it outperforms in hard times.