For This 10% Yielder, A Reasonably Well-Constructed Portfolio Just Isn’t Enough
A Straightforward Approach
Every week, we’ll profile a high yield investment fund that typically offers an annualized distribution of 6-10% or more. With the S&P 500 yielding less than 2%, many investors find it difficult to achieve the portfolio income necessary to meet their needs and goals. This report is designed to help address those concerns.
If the dovish tone we’ve heard recently from Jerome Powell means that the long-anticipated Fed pivot is upon us, it could breathe new life into junk bonds (in the near-term at least). The economic landscape for these troubled fixed income issues still looks challenging to say the least - corporate bankruptcies & defaults are on the rise, credit availability is shrinking and the credit that is available is much more expensive than it was in the past. Still, investors tend to focus on the here and now. That means the notion that interest rates have peaked and monetary policy could shift from hawkish to neutral could draw opportunists back into high yield debt.
The PGIM High Yield Bond Fund (ISD) uses a fairly straightforward approach to selecting bonds for its portfolio, but it also follows a familiar pattern of diving deep into the lower credit quality tiers and adding leverage to try to maximize return potential. The strategy has had some success in the past, but, as is the case with most funds, it’s all about portfolio positioning and cycle timing to try to determine whether or not this is the fund for the moment.
Fund Background
ISD seeks to provide a high level of current income by investing primarily in below investment-grade fixed income instruments. Within that objective, the fund’s management team is relatively unconstrained. It can invest in bonds with varying maturities, but will avoid muni bonds and mortgage-backed securities. As mentioned above, the fund does utilize leverage to enhance yield and total return potential.
With the ability to invest just about anywhere in the corporate high yield market, this is one of the more pure play actively-managed junk bond strategies available. The 23% use of leverage is right in the range of where it could do some good without overdoing it on risk, but the high yield space has been a notoriously difficult one to get your money’s worth out of. Plus, the cost of leverage has gone way up in the past two years and that’ll make it more and more difficult to make it cost effective going forward. According to the fund’s latest annual report, the current total expense ratio considering leverage expenses is 2.45% (the number in the graphic above appears to be outdated). This is going to be a significant headwind, especially considering rates are likely to remain higher for longer.
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