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ETF Specialist

Is High Yield Overvalued?

The high-yield category has increased risks and low absolute yields.

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With record fund inflows in 2012, investors clearly have an appetite for high-yield bond funds. The strong investor demand lowered credit spreads, and the high-yield category returned over 14% last year. While yields have been falling, high yield is the only bond category with a 12-month yield still above 5%. After four consecutive years of positive returns, is now the time to allocate money to high yield, or is the sector fully valued and ripe for a fall?

Market Expectations
Fitch Ratings and JPMorgan are currently projecting a high-yield default rate of 2% or lower, below the long-term average default rate of 4.8%. These predictions are based on United States gross domestic product growing at 2%, the European debt situation stabilizing, and the U.S. debt ceiling issue being resolved by Congress. With the average high-yield bond trading above par and below-average credit spreads, there is not much capital appreciation available, so returns will come predominantly from the coupon. The consensus seems to be projecting returns for 2013 of between 6% and 8% for the sector.

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Timothy Strauts does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.