Fidelity expert eyes high yield bond funds

by Jack Bowers, editor Fidelity Monitor

All things considered, a good argument can be made for putting a portion of a stock-oriented portfolio into high yield bonds.

Such a move is likely to reduce portfolio risk, with little or no impact on overall performance.  Here's a look at our best bets in the high yield sector.

For income-oriented investors, high-yield bonds offer a chance to boost returns by taking on more credit risk.

For growth investors, high-yield provides the opportunity to cut risk while maintaining stock-like returns.

For growth and income investors, high-yield has the potential to outperform traditional asset allocation funds while maintaining similar risk.

Following is a review of Fidelity’s high-yield lineup, in order of increasing risk:

Floating Rate High Income (FFRHX) was designed to generate income similar to that of other bond funds with very little share price impact from interest rate fluctuations.  

Problem is, the fund takes on a lot of credit risk while significantly limiting its capital gain potential to achieve that goal.  

For roughly the same volatility, Strategic Income provides a higher income stream and more capital gain potential. If your goal is to keep risk low, go with Short-Term Bond.

Strategic Income (FSICX) holds a mix of high yield (currently 40%), U.S. government (25%), foreign developed market debt (18%), emerging market debt (12%), and a small amount of cash (5%).

The combined weight of the high yield and emerging market components make up more than half of the portfolio.  

As such, Strategic Income behaves mainly like a high yield fund, except that it has a lower yield and runs with less volatility. Fidelity has an excellent history with this fund, thanks to a strong team of analysts.  

Although we’re not fond of the foreign developed market component, at this point in time it’s less likely to negatively impact the portfolio.

With less than half the S&P 500’s volatility, the fund doesn’t take on enough risk to be considered a stock fund alternative, but it’s a great way to obtain an above-average income stream without much interest rate risk.

Focused High Income (FHIFX) concentrates on bonds that are rated BB – the highest rung on the high-yield ladder. While this helps reduce default risk, in our opinion it doesn’t help enough.  

At 60% of the S&P 500’s volatility, Focused High Income carries more risk than Strategic Income, yet has trailed it over most time periods.  

Better to either go with Strategic Income’s more diversified approach, or step up to High Income, which has the potential of a significantly higher return (High Income’s volatility is 20% greater than Focused High Income).

High Income (SPHIX) is Fidelity’s mainstream high-yield offering. With a 30-day yield that’s above 8%, you get paid handsomely while waiting for high-yield bond values to recover.  

When they do, you’ll earn capital gains on top of the income stream. Volatility is mainly the result of credit risk, and runs about 75% of the S&P 500’s level.

Rising interest rates don’t hurt much in a fund like this, because they usually signal that the economy is getting
stronger, a plus for a fund with a lot of credit risk.  

With near-zero inflation, High Income makes a good alternative to a stock fund – it offers almost the same total return potential as the S&P, but its volatility is much lower.

Capital & Income (FAGIX) goes further out on the high yield limb, with volatility that’s 90% as great as the S&P 500.  

Because the fund invests a significant portion of its assets in leveraged stocks (currently 16% of holdings), we think it has the potential to outperform the S&P 500 in this environment.  

The fund’s overall 30-day yield is a little lower than High Income due to its stock weighting, but we estimate the yield on its bond holdings to be close to 9%.  

Capital & Income is Fidelity’s longest running high-yield fund.  It’s lifetime annual return of 10.4% has been earned over a period of almost 33 years.

Learn more about this financial newsletter at Jack Bowers' Fidelity Monitor.