A well diversified portfolio includes a mix of multiple assets. One option that’s received quite a bit of attention, both good and bad, is high-yield junk bonds. These are bonds of companies with less than ideal credit ratings.
The interest rates, or coupon rates, junk bonds pay are typically higher than more traditional investment-grade corporate bonds because of the higher risk of these issuers defaulting.
Because of the higher default risk, investors who don’t have adequate time or market knowledge to choose junk bonds should consider investing in high-yield bond funds rather than individual opportunities. Mutual funds and exchange-traded funds (ETFs) focused on high-yield bonds offer diversified access to these fixed-income assets that’s easy for everyday investors to tap into.
The Best High-Yield (Junk) Bond Funds
Our pick for the best high-yield junk bond fund on the bond market offers a high level of diversification, access to a wide range of assets, a compelling historic performance, and a strong management team.
1. Best Overall: iShares iBoxx High Yield Corporate Bond ETF (HYG)
Boasting net assets under management (AUM) of over $21 billion, the iShares iBoxx High Yield Corporate Bond ETF is arguably the best junk bond fund on the market. It doesn’t hurt that iShares has one of the most capable management teams on Wall Street today.
The fund focuses its exposure on high paying bonds from U.S.-based companies, keeping investments domestic. Moreover, as one of the most popular high-yield funds on the market, investors won’t have any liquidity issues when they decide to exit the investment.
The fund’s performance has been stellar as well. Iit has only spent three years in the red since its inception in 2007 and has a Morningstar rating of three out of five stars.
With an expense ratio of 0.48%, the fees associated with investing in the fund are slightly above the industry average, but in this case it’s easy to argue the cost is worth it.
The HYG fund lands as the best overall high-yield fund on this list for the same reasons it is one of the most popular junk bond funds on the market today.
2. Best for Emerging Markets: VanEck Emerging Markets High Yield Bond ETF (HYEM)
If you only invest in domestic assets, you’re missing out on about half of the opportunities the global financial markets have to offer. As such, mixing in international assets — especially those from high-growth, emerging markets — is a compelling idea.
The VanEck Emerging Markets High Yield Bond ETF is a simple way to do just that.
With $1.2 billion under management, the fund isn’t the largest on this list, but it’s definitely a great way to access junk bonds from emerging markets. The fund is made up of a diversified list of high-yield bonds from non-sovereign emerging markets around the world.
The fund has had a rocky history, being up five years and down three. But there’s a strong argument that with an overvalued market in the United States, investors will start looking more closely at opportunities in emerging markets, which could give this ETF a boost.
The fund currently has a three out of five star rating at Morningstar and a 0.40% expense ratio, suggesting it offers access to reasonable growth with fees just below the industry average.
3. Best for Tax-Exempt Investments: Vanguard Tax-Exempt Fund Investor Shares VWAHX
If you’re looking for access to high-yield bonds but want to enjoy the tax benefits of tax-exempt bonds, the Vanguard Tax-Exempt Fund (VWAHX) is for you.
The fund invests 80% of its assets in investment-grade municipal bonds, which offer tax benefits. The other 20% of the asset allocation in the fund is invested in non-investment-grade bonds, — junk bonds — in order to increase the level of income the fund generates.
With more than $18 billion in assets under management, the VWAHX fund is one of the more popular high-income funds on the market today. It also boasts a five out of five star Morningstar rating, suggesting it’s one of the better performing funds in its category. All told, the fund has only closed eight years in the red since its inception in 1979 — an impressive feat.
Vanguard is known for low expense ratios, and with a ratio of just 0.17%, the VWAHX fund doesn’t disappoint. The low costs help you hold onto even more of your tax-exempt earnings.
4. Best for Active Management: Invesco High Yield Bond Factor ETF (IHYF)
The vast majority of ETFs — both those centered around stocks and those investing inbonds — are passively managed. Passive ETFs track the movements of an underlying benchmark in an attempt to achieve the same results.
If you’re more interested in an actively managed option, the Invesco High Yield Bond Factor ETF might be the best fit for you.
The fund is managed by the professionals at Invesco, so you can trust your money’s in the right hands. The fund has multiple active traders that are constantly looking for opportunities in the high-yield bond market.
The fund is very new and not yet highly traded, which could lead to liquidity issues. But it’s had a stellar performance, ending its first year well into the green. At the same time, its 0.39% expense ratio makes it one of the lower-cost actively managed funds on the market today.
5. Best for Diversification: iShares Broad USD High Yield Corporate Bond ETF (USHY)
This list started with an iShares bond fund and it’s going to end with one.This particular fund was chosen because of the significant diversification found in its portfolio. Although most bond funds are diversified, the iShares Broad USD High Yield Corporate Bond ETF takes it to the next level by tracking a broad index of the entire U.S. high-yield corporate bond market, offering a more robust shield against risk.
With an expense ratio of 0.22%, it’s one of the lowest cost funds on this list as well.
The performance of the fund has been compelling throughout its short history, and if the beginning of 2022 is any indication, this trend is likely to continue. All told, if you’re looking for a healthy mix of high-yield junk bonds to add to your list, the USHY fund is a great option.
Methodology: How We Select the Best High-Yield Junk Bond Funds
We used six key metrics when determining which bond funds would make this list. We focused on highly diversified funds that come with a relatively low cost, include a mix of credit quality to provide safety through diversification, have a history of solid performance, produce compelling income, and offer at least some level of liquidity.
Here are the criteria we used to find the best junk bond funds:
The expense ratio of a fund is the percentage of your holdings you’ll pay each year in fees. High expense ratios have the potential to cut deep gashes into your profitability.
So, we paid close attention to expenses and only listed funds that offered lower expense ratios.
Junk bonds are defined by a credit rating of BBB or lower, offering investors higher returns in exchange for accepting increased credit risk.
However, the best high-yield funds invest in a mix of both junk bonds and investment-grade bonds. This gives investors a way to tap into the larger gains offered by junk bonds while keeping their portfolios relatively safe.
When choosing bond funds to list, we looked closely at the asset allocation within the portfolio and gave heavier weight to funds that offered a healthy mix of both junk and investment-grade bonds.
Investing is all about making money, and we didn’t want to point you to a bond fund that was going in the wrong direction. We looked at the historic performance of many comparable bond funds to determine which of the options should claim the top positions.
Some investors prefer a mix of domestic and international assets. Some prefer a mix of short-term and long-term assets. Some want to be as diversified as possible.
We attempted to address the needs of all investors by including funds with allocations to assets in a wide range of categories.
The reason investors want to invest in junk bonds is for access to increased income. When determining which funds deserved to be listed, we considered the dividends each pays investors.
Even if an investment grows dramatically in value, it’s not worth much if you can’t get out of it. Liquidity represents the ease of turning the investment into cash when you decide it’s time to exit your position.
When curating this list, we looked at the daily trading volume of each ETF we assessed. Although some of the options on the list have relatively low trading value, investors who wish to exit their positions should be able to do so within at least a 24-hour period.
High-Yield Junk Bond Funds FAQs (Frequently Asked Questions)
It’s only natural if you have questions about junk bond funds. Here’s what you need to know:
Do Bond Funds Pay Dividends?
Like other bonds, junk bonds offer income by paying interest, or coupon rates, to investors. ETFs hold a variety of bonds and distribute the income generated from them to investors as dividends.
Are High-Yield Bond Funds a Good Investment?
The answer to this question depends on your investment objectives and your appetite for risk. Junk bonds come with increased credit risk and should only be used by investors who are comfortable accepting that risk.
With that said, if you’re not happy with the returns offered by traditional bonds in your investment portfolio, junk bonds do offer higher yields. As with any investment decision, it’s important to weigh the chance for higher returns against your risk appetite and investment objectives before diving in.
Are Junk Bonds Risky?
Junk bonds are riskier than their investment-grade counterparts because these companies have had credit difficulties or little to no use of credit in the past. As such, the borrowers, or the issuers behind these bonds, aren’t the best candidates for lenders. They stand a higher chance of defaulting than do well established companies with excellent credit ratings.
Moreover, junk bonds experience more volatility than investment-grade bonds, further adding to the risk of the investment. The trade-off is in the potential to generate higher returns.
Why Would Investors Buy a Junk Bond?
Investors are willing to accept the increased risk of investing in junk bonds because these bonds offer the highest returns among bonds.
Is It Safe to Buy BBB Bonds?
BBB is the highest credit rating that still earns the label of “junk bonds.” If you’re going to invest in this category and you’re new to high-yield bond investing, this is likely the safest place for you to start.
Should I Invest in Fallen Angels?
Fallen angels are companies that have recently experienced financial troubles. In some cases these companies make a quick recovery, and in others, bankruptcy may be around the corner.
Before investing in a fallen angel, do some research to determine why the company has found itself in financial trouble. You can judge whether that financial trouble will be resolved in short order or poses a more serious risk to the company’s future viability.
How to Choose the Best High-Yield Junk Bond Fund
Choosing a high-yield fund is a relatively simple process. There are many junk bond funds that offer a healthy mix of returns and safety thanks to diversification. When you invest in any bond fund, any one bond issuer defaulting won’t bring the value of your investment to zero.
When comparing your options for high-yield bond funds, consider the same criteria we used to select our favorites: performance, expenses, liquidity, asset allocation, income, and mix of credit quality.
As with any other investment, when investing in these funds, a little research goes a long way.