Harnessing High Income with Quality Is Possible

Advisors know that generating income for clients this year is a trying task as the widely observed Bloomberg US Aggregate Bond Index is down more than 10% year-to-date.

Making matters worse for advisors and clients is that, not surprisingly, a variety of other fixed income assets are faltering as well as the Federal Reserve rolls out aggressive interest rate increases due to being late to the inflation-fighting party.

Fortunately, equity income is picking up some of the slack and while many high-dividend stocks are performing admirably this year, plenty of other dividend payers are slumping. In other words, dividend equities, broadly speaking, are simply proving less bad than the S&P 500.

There are other encouraging developments. Advisors don’t necessarily have to sacrifice quality in a big way in order to generate income from bonds on behalf of clients. Here’s how that goal can be accomplished.

Reasons to Revisit High-Yield

Fortunately, there are reasons for advisors to at least evaluate high-yield debt, including fallen angel bonds. Among those are reasons are still modest default rates and data suggesting the specter of a recession isn’t being reflected in the junk bond market.

Quiet as it’s being kept, high-yield corporate bonds are in rally mode. So much so that this corner of the bond market is outperforming less risky counterparts by wide margins.

“Since then, the HY market has gone from being one of the worst performers in the U.S. fixed income space to one of the better ones,” says WisdomTree’s Kevin Flanagan. “To provide perspective, HY was posting a year-to-date return of -14% in early July, but that has since improved by almost half to -7.7%, as of this writing. Compare that to the benchmark Agg, where year-to-date performance during this same period has remained in the roughly -9% to -10% range.”

As advisors well know, in the right environments, junk bonds are ideal income ideas and suitable for a variety of investors. Of course, those clients want income for the added risk that comes along with high-yield debt. Fortunately, advisors can deliver a compelling income proposition with junks bonds today.

“Back to the ‘income’ part of the equation. HY’s yield to worst (YTW) is now roughly 7.60%, up nearly +340 bps year-to-date,” adds Flanagan. “As recently as July of last year, the YTW was only about 3.50%. Interestingly, the U.S. high-yield market has rallied in the wake of softer data that suggested the economy is in a ‘technical recession.’ This yield level places HY in its more well-known traditional role of an ‘income provider’ in bond portfolios, and could help explain this recent rally, as well as being a sign that unless there is a deep downturn, the HY market has already discounted Fed-induced economic softness.”

Quality Junk: It’s Real and Accessible

The combination of quality and junk bonds isn’t as elusive as advisors and clients are apt to think. Enter the WisdomTree U.S. High Yield Corporate Bond Fund (WFHY).

WFHY relies on a fundamental approach, including a quality screen, to steer investors away from potential credit downgrades and defaults. That’s an all-weather approach applicable for any income-hungry client.

“The bottom-line message is that ‘there’s income back in fixed income’, but the current market environment has made it clear that a strategy that emphasizes fundamentally sound companies with strong cash flows is prudent in a time of economic uncertainty,” concludes Flanagan.

Related: Rough Times Aside, Bond ETFs Still Have Benefits