Wall Street Journal columnist Jason Zweig is warning junk bond enthusiasts to think twice before investing in junk bonds, especially junk bond exchange traded funds. In addition to the junk bonds themselves being overbought, the exchange traded funds that own them trade at a premium over the net asset value of the junk bonds. When you add the expense ratio to the premium, investors are now paying 2 percent more than the current value of the bonds. All of this means that, if investors start to dump junk bonds, the ETFs will decline about three times more than the underlying bonds. “‘Junk’ ETFs: Tread Lightly,” Wall Street Journal).
“ETFs have their known costs and benefits. And this is one of their costs,” Oleg Melentyev, head of high-yield corporate strategy at Bank of America Merrill Lynch, was quoted as saying.
The extremely low interest rate environment has hurt older Americans on fixed incomes who need their investments to produce income to meet their obligations. They are understandably seeking higher yields, and are often told that higher yields are available without incurring higher risk. As Mr. Zweig put it, however, investors considering such an alternative should “give it the sniff test, so you don’t end up with a smelly surprise.” Advisors should likewise be very careful to explain the risks as well as the benefits of a higher yield investment strategy.
Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.