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Investment Risks to Watch For in the High-Yield Bond Market

By U.S. News & World Report

Over the last several years, investors have been forced by the Federal Reserve’s policy to take on more risk to obtain yield on their investments.

As yields on CDs declined from the 5 to 6 percent range in 2008 to a little more than zero, investors have purchased lower quality and riskier investments in an effort to maintain income. Also, the credit markets have been stable since 2008, which has led to a state of complacency. Investors need to pay attention to what is happening with credit markets today, especially in the high-yield bond space.

The decline in commodity prices is pushing some high-yield bonds toward default. The pressure on the energy and metals and mining sectors does not appear that it will be relieved in the near term. Energy and metals and mining issues make up a sizable percentage of high-yield bonds.

Accordingly, high-yield funds had a negative return for 2015, but things could get much worse. Investors see the yields coming from these funds as attractive, being in the range of 7 to 8 percent [using the iShares iBoxx High Yield exchange-traded fund (ticker:HYG) as a gauge].

The yield looks attractive, but what isn’t apparent is that this market has become bifurcated. Yields on energy and commodity companies have expanded to the 12 percent range; the remainder of the market is in the 5.5 percent range. The 12 percent yield indicates a high expectation of commodity and energy companies defaulting. Standard and Poor’s downgraded more than $1 trillion of bonds last year and the pace appears to be picking up.

On the surface, investors would naturally be attracted to a yield of 8 percent; however, they could be in for a rude awakening if financial stress in the energy area gets worse — many of those companies could default, leaving investors with a large loss.

As of June 30, more than 80 percent of these companies’ cash flow was going to service their outstanding debt — this leaves little cash to fund operations. During this time, oil was still trading well above $50 per barrel. The situation has only gotten worse, with oil now trading in the $30s.

To add to the challenges, many high-yield bonds are not liquid. Individual investors likely own high-yield bonds through an ETF or an open-ended mutual fund. The general belief is that if they choose to sell they can easily do so, which is correct.

However, what is not usually obvious is what can happen to the price of a fund in an environment where people become fearful. If concern about the credit cycle gets worse and investors start selling their funds in large volume, the prices of the bonds underlying the funds can drop significantly, even without defaults. As fund investors sell, the fund’s manager is forced to raise cash to pay out the redemption, and the manager has to sell part of the fund’s holdings.

The corporate bond market is made up of thousands of different issues, many of which do not trade on a regular basis. When the fund manager is forced to sell, he/she needs to find a buyer. In a time of high-selling pressure, buyers tend to offer low-ball bids, or no bids at all.

Remember, the fund’s manager has to sell, practically at any price, to meet the redemption request. The liquidity issue may be a larger risk to high-yield bonds than the default issue.

One thing is very clear: Energy and mining companies are facing ongoing and increasing headwinds. There is good reason the yields on energy and mining bonds has shot up so much, given the trouble they face. If investors own high-yield funds, they need to understand the exposure their funds have to these sectors — and to the risk of defaulting bonds or large redemptions by other holders.

I do not think now is a time to be taking undo risk in the high-yield market. Some funds offer a different approach to high-yield exposure, however. Consider:

Market Vectors Fallen Angel High Yield Bond ETF (ANGL): Its holdings are junk bonds that were originally issued with an investment grade rating. Consequently, the credit composition of the fund is better than other funds. The SEC yield is 5.9 percent. While giving up some current income, we believe the overall superior credit profile of the fund will serve investors well. It likely will not avoid the volatility inherent in high-yield funds during a time of fear, but the credit quality of the fund should minimize the negative impacts of large defaults.

Metropolitan West High Yield Bond (MWHYX): The team that manages the fund has been in place since 2002. Their process focuses on individual credit analysis and attractive valuations.

Disclosure: Neither Phillips, his firm or the firm’s clients own a position in the aforementioned funds.

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Investment Risks to Watch For in the High-Yield Bond Market originally appeared on usnews.com

Don’t Settle for Student Loans to Pay for Online Education

By WTOP Staff
Online college programs are becoming a more popular choice for prospective students, with one study finding that more than 6 million students enrolled in at least one online course in fall 2015. The popularity of these courses can be attributed in part to their flexibility with working adults' schedules, students' ability to progress more quickly through online programs and, oftentimes, cheaper tuition. [See 10 low-cost online bachelor's programs for out-of-state students.]Online degrees can be beneficial to many college students, but some studies have shown online learners complete their programs at lower rates than students at traditional brick-and-mortar campuses. Individuals with student loans but no degree comprise two-thirds of defaulted borrowers. Though these numbers are not encouraging, just like for traditional programs, there are ways to reduce how much you'll need to borrow for an online program to ensure you won't become one of these statistics. Don't just settle on borrowing student loans to cover the whole cost of your program and living expenses. Instead, start thinking about how to cut costs and cover your balance in different ways, such as the following. -- Grants and scholarships: Even though you are taking an online course, you can still apply and receive grants and scholarships. But your first step should be to complete the Free Application for Federal Student Aid, commonly referred to as the FAFSA, which will allow you to receive a Pell Grant if your expected family contribution is low enough. The EFC criteria and award amounts are adjusted annually, but the 2017-2018 academic year awards range from $606 to $5,920, which could significantly lower the amount you borrow annually. Your next step is to apply for scholarships. You can start by checking online scholarship search engines, such as the Salt Scholarship Search, College Board's BigFuture and Peterson's. But don't forget to take advantage of local organizations and your school's financial aid office. Both may offer scholarships that you can't find with a national scholarship search. [Review these 10 sites to kick off your scholarship search.]For instance, organizations like the Elks Club, Knights of Columbus or the Rotary Club typically offer scholarships annually to local students. Just because you're going to school online doesn't mean you're ineligible. Visit your local library for scholarship listings, and ask around town. You might be surprised how many local organizations offer scholarships. While these scholarships typically aren't large, every little bit counts. Each dollar you receive in a scholarship is a dollar you don't have to borrow and pay interest on. -- Work-study: Another option for online students may be work-study awards. Not all students enrolled in online programs are eligible, but students at some schools -- including, for example, SUNY Empire State College and Liberty University -- are. Work-study awards are not given upfront like scholarships and grants. In most cases, they are an offer to earn up to the awarded amount if you secure an eligible work-study job. While there is a misconception that all work-study jobs must be on campus, students can work for off-campus, nonprofit or public employers as long as the work is in the public's interest. You may be able to work for a for-profit employer if the job is relevant to your course of study. No matter who the outside employer is, it will need to have an established agreement with your college for you to receive work-study funds. Remember, to be eligible for federal financial aid, you must be enrolled and pursuing a degree or certificate. If you're not working toward a credential, Pell Grants and work-study won't be option, but you may still be able to take advantage of private scholarships -- just be sure to read the eligibility criteria carefully. [Explore what to know about financial aid in online programs.]-- Pay as you go: One of the great benefits to enrolling online is the flexible schedule, which can allow you to complete your college coursework around your responsibilities. But prospective students often overlook using their part- or full-time job earnings as an option for paying for college. Almost 80 percent of college students in 2015 worked at least part time while attending classes, according to the National Center for Education Statistics. By budgeting and thinking strategically about your college costs, you can likely reduce your dependence on student loans by paying a portion out of pocket. Many -- but not all -- online programs are less expensive than traditional programs and often have shorter payment periods. Six, eight or 10 weeks are common course durations. Because of the frequency of payments in an online setting, you may be well-placed to pay as you go and possibly avoid borrowing altogether. Attending college online and avoiding student loans may be challenging, but if you are willing to put in the effort, you can limit the amount you need to borrow. More from U.S. News Q&A: Understanding Student Loan Discharge Eligibility Student Loan Refinancing Isn't Right for All Borrowers
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