How to pursue high income with relative safety while diversifying your portfolio

By Philip van Doorn

These high yield bond funds have a high rating for long-term returns

Some investors are taking on more risk than they realize with stock index funds. Others may need income now or shift their portfolio mix for the next phase of life, when a stream of dividends will be more important than pursuing long-term stock market growth over decades.

Brandywine Global, part of Franklin Templeton, manages two bond funds that select from the high yield segment.

These are bonds or other corporate debt instruments that are rated below investment grade or have no rating. They are commonly known as “junk bonds” and their combination of high interest payments and higher credit risks than investment grade bonds means that they are probably best left to professional asset managers. The two major credit rating agencies are S&P Global and Moody’s Ratings. At S&P, a bond is considered investment grade if it has a rating of BBB- or higher. At Moody’s, the minimum investment grade rating is Baa3. You can view S&P’s rating hierarchy here and Moody’s rating scale here.

Many bonds and other instruments issued by borrowers in the high-yield space are only available to institutional investors. But individual investors can participate in this market through mutual funds.

There’s another reason to think about adding bond exposure to your portfolio. Chasing high dividends in the stock market can come at a steep price. In his Intelligent Investor column in last week’s Wall Street Journal , Jason Zweig cited several examples of high-dividend stock market approaches, including exchange-traded funds, that had led to brutal declines in account values ​​over the years. Yes, the income flowed, but investors paid for it with capital erosion.

Diversify by asset class

The S&P 500 SPX has performed very well in recent years, but its market-cap weighting means it’s highly concentrated at the top, and that level of concentration has grown. Combined, shares of Apple Inc., (AAPL) Microsoft Corp. (MSFT) and Nvidia Corp. (NVDA) make up 19.1% of the $539 billion SPDR S&P 500 ETF Trust SPY’s portfolio.

According to a recent analysis of 100 years of data by analysts at MFS Investment Management, we have been in the current wave of increasing concentration in the U.S. stock market for almost 18 years.

Below is an overview of the research and stock indexing approaches that could perform best after the concentration peak.

And here’s another indexing approach within the S&P 500 that reduces concentration risk.

But you can also diversify by taking some of your money out of the stock market entirely, while still chasing decent returns. And if you want income, the BrandywineGlobal Corporate Credit Fund and the BrandywineGlobal High Yield Fund provide that monthly.

The two Brandywine Global high-yield bond funds

The BrandywineGlobal Corporate Credit Fund BCAAX and the BrandywineGlobal High Yield Fund BGHAX are co-managed by John D. McClain and William P. Zox. The following discussion of the funds is limited to their Class A shares, which are generally available to investors with a minimum of $1,000. Both funds have a 3.75% sales charge listed in their prospectuses, but this charge is waived for investors who purchase shares through major brokerage platforms, such as Charles Schwab or Fidelity.

Both funds also have Class I shares available through investment advisors, which can have high minimums depending on the relationship between the advisor and Franklin Templeton. The Class I shares have lower costs and therefore higher dividend yields, but for simplicity we will focus on the Class A shares here.

McClain described MarketWatch’s fund approaches. Before he gets into his comments, here’s a summary of the two:

The $2 billion BrandywineGlobal Corporate Credit Fund has a 30-day SEC yield of 6.25%. Quoted yields and returns for bond funds are net of expenses, which are 0.86% of assets under management for this fund’s Class A shares. The 30-day yield is best used for comparison purposes and is intended to provide a sense of short-term annualized returns. This fund was formerly known as the Diamond Hill Corporate Credit Fund, which was launched in September 2002. When Franklin Templeton acquired the predecessor fund in 2021, its assets and liabilities were absorbed by the current fund, with no changes to the investment policy or portfolio management team.

The $2.4 billion BrandywineGlobal High Yield Fund has a 30-day yield of 6.58% for its Class A shares, which have an annual expense ratio of 0.92%. The fund was formerly known as the Diamond Hill High Yield Fund, which launched in December 2015. The current fund assumed all of the assets and liabilities of the former fund when it was acquired by Franklin Templeton in 2021, with McLain and Zox remaining as portfolio managers.

Both funds have five stars (the highest rating) in the Morningstar fund category ‘High Yield Bond’.

Here are the one-year returns and the average annual returns for longer periods through July 31 for the Class A shares of the BrandywineGlobal Corporate Credit Fund and the Investor Class shares of its predecessor fund, compared to the benchmark, the ICE BofA US Corporate & High Yield Index. The fund’s performance is net of expenses and excludes any sales charges, which have now been waived as explained above. All returns include reinvested dividends.

   Fund or index                                       1 year  3 years  5 years  10 years  Since inception (Sept. 30, 2002) 
   BrandywineGlobal Corporate Credit Fund - Class A    11.71%    3.18%    4.96%     5.52%                             6.47% 
   ICE BofA U.S. Corporate & High Yield Index           7.59%   -1.78%    1.56%     2.95%                             5.07% 
                                                                                       Sources: Franklin Templeton, FactSet 

And here are the average returns through July 31 for the BrandywineGlobal High Yield Fund’s Class A shares and its predecessor fund’s Investor Class shares, compared to the benchmark, the ICE BofA US High Yield Index.

   Fund or index                                 1 year  3 years  5 years  Since inception (Dec. 4, 2014) 
   BrandywineGlobal High Yield Fund - Class A    12.50%    3.33%    6.14%                           6.92% 
   ICE BofA U.S. High Yield Index                11.03%    2.19%    4.03%                           4.83% 
                                                                     Sources: Franklin Templeton, FactSet 

Both funds have far outperformed their benchmark indices, which is even more impressive when you consider that the indices have no fees.

Two different approaches to the high-yield space

BrandywineGlobal Corporate Credit Fund

When asked to explain the differences between the two funds, McLain said the BrandywineGlobal Corporate Credit Fund can be considered “a high-quality, high-yield portfolio.” It is the older of the two funds, with a lower credit risk profile and lower yield.

Zox has been a portfolio manager for the Corporate Credit Fund and its predecessor fund since 2008, after working with the previous managers since their inception in 2002. McClain became a portfolio manager for the fund in 2014. McClain said the Corporate Credit Fund’s strategy was created in the wake of the tech stock bubble of the early 2000s, “when you had a lot of retirees or people approaching retirement who were losing money at the wrong time.”

“The goal was to create a somewhat safer way to generate income that is in line with what a required minimum distribution (from a retirement account) would look like for a client,” he said. He outlined “soft targets” for the income-generating fund of 3 percentage points above the U.S. consumer price index during periods of low inflation, and a 7% return when inflation is high.

This fund, then, is designed to take a lighter approach to the junk-bond space, McClain said. “The client gives us the ability to increase or decrease the risk in the portfolio,” he added. During a period of bond market stress, the fund will take advantage of market conditions, applying the managers’ credit analysis to buy deeply discounted securities to boost the portfolio’s returns and set up capital gains over time. Such moves can actually increase the fund’s allocation to investment-grade bonds. The portfolio was 70% investment-grade “after the great financial crisis” in 2009, he said. As of July 31, it had 181 investments and 14.4% was allocated to investment-grade securities, with about 79% of the portfolio invested in securities issued by U.S. companies.

Before we look at the other fund, let’s return to the topic of high-yield stock market investing and capital erosion. Zweig provided examples. Here’s another: The $7.7 Global X Nasdaq Covered Call ETF QYLD has a dividend yield of 12.68%. It invests in the Nasdaq-100 Index NDX, which itself consists of the largest 100 non-financial companies in the full Nasdaq Composite Index COMP. QYLD generates income by writing covered call options on the entire index, a process described here .

QYLD has done a great job of providing double the annual dividend yield, but the fees have been a significant erosion of capital over the years. The fund’s closing price on September 6 was $17.18. That was down 32% from $25.34 on Friday, September 5, 2014.

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