Cracks are starting to appear in the economy, and that means now is a good time for investors to get a little pickier about where they dig for portfolio income. The first-quarter U.S. gross domestic product reading , released last week, showed the economy shrank 0.3% as uncertainty around President Donald Trump’s trade policies dragged on businesses. Further, investors are fresh off of a tumultuous April in which the 10-year Treasury yield tumbled and then rose to top 4.5% – and the S & P 500 briefly slid more than 20% from the record high it reached in February. Tuesday saw fresh volatility for investors who are still awaiting trade agreements, as the major averages tumbled for a second day. While many investors like the idea of padding out their portfolio with attractive yields, they should be cognizant of the quality of the assets paying out that income. High-yield bonds, for instance, have a close correlation with stocks and their prices will likely slide as equities sell off. Consider that the iShares iBoxx High Yield Corporate Bond ETF (HYG) slipped about 0.4% in April, while the S & P 500 lost nearly 0.8% that same month. HYG 1M mountain The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) in the past month “Periods of volatility are painful but good reminders to understand what is under the hood of the portfolio and to stay diversified,” said Thomas Murphy, senior manager research analyst for Morningstar. “Remember the role bonds play in the broader portfolio: It’s ballast for the equity allocation.” A preference for higher quality Investors were willing to take a risk last year amid interest rates that remained relatively high, putting $25.6 billion into bank loans and collateralized obligation exchange-traded funds in 2024, according to State Street. Large investors can buy bank loans, which institutions make to companies, and benefit from the floating coupon rate on the loans. While the loans may be investment grade, they are secured by the borrower’s assets. Collateralized loan obligations (CLOs) are similar in that they are pools of floating rate loans to businesses. Within an individual CLO, there are tranches, which have their own risk characteristics. A triple-A rated CLO is first to get paid if a borrower goes bankrupt. While the yields on these ETFs are attractive – upward of 5% for some and topping 7% for others with lower credit quality – investors should be wary of pursuing income without thinking about the quality of the underlying loans. “These are small companies with a lot of leverage on their balance sheets,” said Kathy Jones, chief fixed income strategist at Schwab Center for Financial Research. “They are leveraged to the economy because they are supposed to be growth oriented. When rates rise, the floating rate aspect is nice, but rates are likely to fall.” Investment grade plays To that end, Maulik Bhansali, co-head of the core fixed income team at Allspring Global Investments, notes that there are still attractive opportunities in investment-grade fixed income and sources of 5.5% to 6% yield. “At a high level, there’s a lot to like about the investment-grade fixed income market, and you can get that without taking a whole lot of risk on the credit side of things,” he said. Bhansali called out several sectors of investment-grade bonds he likes. First, there are top-quality banks. “They have the gas in the tank to weather what might come, and they are pretty much insulated from the direct tariff risk that’s out there,” he said. He also likes utilities and health care. “These are high quality sectors that should respond well in a downturn, and they are pretty steady Eddie as it goes,” Bhansali said. “They trade at relatively cheaper levels, and I think there’s a lot of value.” Within health care, he likes large pharmaceutical names and managed care companies. Finally, he highlighted agency mortgages and the asset-backed securities market. “These are securities that tend to get dislocated when there is a lot of interest rate volatility, which we have right now,” Bhansali said, referring to agency mortgages. They are “a spot where you can pick up high-quality securities with attractive cash flows, 5.5% yields.” “The main theme is that you don’t need to reach in order to achieve attractive returns across the high-quality spectrum,” he added. Core bond funds For investors seeking a mix of diversification and quality, core bond funds might fit the bill, said Murphy at Morningstar. “Core bond portfolios offer a good building block to a fixed income portfolio because you have that broad exposure to the fixed income market,” he said. Investors should look for solid active managers and names that leverage strong analyst teams, Murphy noted. As they research core bond funds, investors should understand the credit quality of the underlying portfolio, as well as the duration – or the portfolio’s price sensitivity to swings in interest rates, he added. “Look at prior months of volatility and understand the biases in these funds,” Murphy said. “Stick with active managers, good managers who have weathered periods of volatility and are time tested.”
