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The Hidden Risks of High-Yield ETFs

While investors are eager to pay up for high yields, the enthusiasm could melt suddenly. During the past year, the SPDR ETF has swung back and forth, rising to a top premium of 3.21% and falling to a discount of -3.65. An investor who bought at the top and sold at the bottom would have lost more than 6% because of the swings in pricing. When ETFs sell at premiums, investors should move cautiously, says Paul Amery, editor of "You should only buy at a premium if you think that the market is going to continue to rise," Amery says.

Will high-yield ETFs crash any time soon? Probably not. Corporate balance sheets are healthy, and annual junk bond default rates are running at less than 2%, compared to the historical average of 4%. But after the big rally, investors should not buy a high-yield ETF and expect to achieve sizable capital gains.

Vanguard Group recently issued a word of caution. In a press release, Vanguard CEO Bill McNabb noted that some shareholders were selling Treasury funds and shifting to high-yield funds. That could be a risky move, he warned. McNabb announced that he was barring new investors from Vanguard High-yield Corporate Fund (VWEHX), an actively managed mutual fund. At a time when investors were flooding into the fund, the portfolio managers thought that it would be difficult to manage more cash. Investors who crave high yields should take note of the Vanguard move. If the experienced Vanguard team is wary about finding bargains, then other investors should approach high-yield bonds with caution.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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