High-yield bond funds are mutual funds that own bonds from corporations with non-investment grade credit ratings. The term "junk bonds" gives these bonds a bad connotation, but many well-known U.S. companies have non-investment grade ratings, and high-yield bonds can provide excellent returns to investors. Using a mutual fund is a good way to get high-yield bond exposure because they provide professional portfolio management and diversification in the high-yield market.
1. Select a list of high-yield bond funds to evaluate. If you plan to make a high-yield fund investment, evaluating several funds together will allow you to select the one that best fits your investment risk tolerance. Your list may consist of funds recommended by financial advice magazines or you can pick the high-yield fund offering from a list of different mutual fund families.
2. Evaluate the expense ratios of the funds on your list. The expense ratio for each fund can be found on the fund's webpage or in its prospectus. According to the Investment Company Institute 2011 Factbook, the average expenses for taxable bond funds is 0.95 percent; 80 percent of bond funds fall between 0.49 and 1.78 percent. All other factors being equal, a bond fund with a lower expense ratio will provide a higher return to investors.
3. Evaluate the credit quality of the bond portfolio of each fund on your list. A bond fund will provide a breakdown of the credit ratings of the funds in its portfolio. High-yield bonds have credit ratings ranging from BB+ at the high end down to single C. A fund with an average credit rating of BB will hold a higher-quality but lower-yielding portfolio than a fund with a average credit quality of CCC.
4. Compare the average annual returns of the funds on your list over several multi-year periods. The funds should have at least three and five-year return results. If you have 10-year average return results, use those as well. Again, this information will be provided on a fund's website.
- Set up a matrix with your list of funds and give each fund grades in the categories discussed here. The fund with the best average grade wins.
- Current dividend yield is not a good evaluation criteria for high yield funds, even if yield is in the description. Corporate bond prices can fluctuate significantly and a fund manager who is good at selecting bonds that increase in value provides added value to shareholders.
- Of the over 500 available high-yield bond funds, only about 20 are no-load funds. The high-yield sector of the mutual fund universe where the broker sold, load funds may provide better investment choices.
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