High-Yield Bond Funds for the Daring

High-yield debt remains attractive in 2011 but there are some important caveats for investors.
By Don Dion ,

NEW YORK (TheStreet) - Throughout the New Year, the markets are sure to see a variety of new trends develop and shape the investing landscape. However, it is also important to keep in mind the strategies which worked in 2010.

For instance, high-risk debt, a wildly population investment in the past year, will likely continue to be sought after in 2011.

High-yield and distressed debt has become an attractive region of the market for investors who are still warming up the economy. As the markets recover, risk tolerant investors who have stuck to the sidelines with cash or U.S. Treasuries may find high-yield debt an attractive medium between these ultra-conservative options and riskier asset classes such as stocks and commodities.

Two of the most promising ways to access this riskier slice of the bond market are the

iShares iBoxx $ High Yield Corporate Bond Index Fund

(HYG) - Get Report

and the

Third Avenue Focused Credit Fund

(TFCIX)

.

HYG's index is composed of a diverse collection of corporate bonds rated below investment grade. This fund properly protects investors from the gut-wrenching volatility inherent of this asset class thanks to its broad diversification. HYG's index is comprised of over 400 positions. All told, the fund's top 10 holdings account for less than 9% of its total assets.

Companies whose debt makes up the fund's largest positions include

CIT Group

(CIT) - Get Report

, Lyondell Chemical Company, HCA and

Community Health Systems

(CYH) - Get Report

.

Launched in the second half of 2009, Third Avenue's distressed debt fund appeared just in time to benefit from investors using high-yield and distressed debt to take cautious steps back into the marketplace. In the short time it has been available the fund has already managed to gather $1 billion in assets.

Like HYG, this mutual fund option boasts exposure to the debt of companies which run the risk of defaulting. However, another large percentage of the debt underlying the Third Avenue product is already in default or issued by companies which are currently facing, or already in bankruptcy. Given the high caliber of risk associated with this debt, TFCIX is a more risky endeavor that HYG. Therefore, even risk tolerant investors should set aside only a small percentage of their portfolios for this product. TFCIX's minimum investment is $2,500.

Aside from providing investors with exposure to this attractive corner of the bond market, high-yield and distressed debt-focused ETFs and mutual funds will also provide investors with heavy distributions in 2011. HYG's yield currently stands at 8.5%. TFCIX, meanwhile, has paid out a 5% dividend. This income will provide investors with some added comfort when economic turmoil inevitably crops up.

There are a number of cost-related factors to keep in mind when gaining exposure to these two funds. Due to the fact that the fund is actively managed, TFCIX is a particularly more expensive option than HYG. HYG's expense ratio is currently 0.50% while TFCIX's net operating expenses total 1.40%. Additionally, investors holding the mutual fund for less than a year are subject to a 2.0% early redemption fee.

As the markets continue along the road to recovery, high-yield and distressed debt products such as HYG and TFCIX are options income-oriented investors should keep on their radars in 2011.

Written by Don Dion in Williamstown, Mass.

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At the time of publication, Dion Money Management owns iShares iBoxx $ High Yield Corporate Bond Index Fund.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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