Screening Funds

How We Screen High Yield Bond Funds for Tracking, Analysis, and Investing

Overview and Summary
I thought it would be useful to describe how we screen and select high yield bond mutual funds for tracking, technical analysis, and possible investing. In a post, I indicated a few related reasons why we do not invest in Exchange Traded Funds (ETFs), corporate high yield bond, or otherwise.

Before I get started, I would like to reiterate that this is what has worked for me and it is just my opinion based on my experience. This article is not investment advice - it should be used for general information and educational purposes only.  For more information, please see the disclaimers at the end of this article and on the tab of our home page.

That said, there are a number of criteria, which carry relatively different weights, that I consider when selecting high yield bond mutual funds for analysis and investing, including:

Threshold Criteria:
  • The mutual fund company's minimum initial investment amount (assuming the fund is open to new investors)
  • The mutual fund company's sales fees, if any (i.e., front-end load, deferred loads, redemption fees)

In short, a fund must be open to us as a new investor (if that is the case), have a low enough minimum investment amount (compared to the amount we will invest), and not have any sales fees whatsoever. Funds that do not pass these criteria are generally eliminated from further evaluation (unless I want to track a fund as an indicator because it has clear and repeatable chart patterns and superior price performance - I may then use this fund to determine when to invest in others).

Modifying Criteria:
  • Mutual fund company's fund expenses (i.e., management, 12b-1, administrative)
  • Brokerage's transaction costs for the fund (i.e., trade commissions (if any) and associated early redemption fees)
  • The mutual fund inception date and/or manager/management

 I may further eliminate some funds if they have excessive expenses and/or brokerage transaction costs.  Also, if the mutual fund has a short track record (recent inception date), and/or fund manager(s) have changed recently and/or have a lack of experience, I may eliminate these funds from further consideration.

Balancing Criteria:
  • Dividend yield  (compared to other funds)
  • Relative price performance (compared to other funds)
  • Chart patterns (clear or poorly defined)

After I am left with a handful of funds after considering threshold and modifying criteria, I further analyze and rank them using these balancing criteria.  I may use one fund with relatively clear chart patterns and superior price performance to determine when to buy/sell all similar mutual fund holdings (e.g., all municipal high yield bond).

Note that many of these criteria (except chart patterns) can be entered into a mutual fund "screener" (i.e., a database query tool) available through your on-line brokerage website (i.e., TD Ameritrade, ETrade, Schwab) or Morningstar, etc., to make the selection process much easier.  It is beyond the scope of this article to provide guidance on how to use a mutual fund screener as they vary somewhat depending on provider, but my experience is that they are not difficult to use once you play with them a bit.  Also, once set up, the screening criteria may be saved for future use if it is done through an established user account.

Each of these criteria are discussed in more detail below.

Mutual Fund Company's Minimum Initial Investment Amount
Minimum initial investment amount varies widely between funds - from hundreds to a million dollars.  The bottom line is that I won't be investing in a fund if I can't or don't want to invest the required minimum initial amount.  So funds with too high of an initial investment amount can be eliminated right away.

This information is readily available in a number of places (e.g., Morningstar website, fund company website, brokerage's website). Since everyone probably has access to it, this is what it looks like on the Morningstar website (as of 3/24/2014) for corporate high yield bond fund AHBIX (enter "AHBIX" in quotes box and then go to the "purchase" tab).

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AHBIX - Minimum Investment Information as of 3/24/2014

Note that this table also indicates whether or not the fund is open to new investors, which is another initial check to make.

It is up to blog readers to determine what they are comfortable with, but I typically invest at least $20,000 in a fund to make it worthwhile (i.e., taking into account research/analysis time, transaction fees, investment returns, etc.).  

I have shown the information Morningstar provides, but if you buy through a brokerage, it possible that the amount might be different (possibly less) if the brokerage has a special arrangement with the fund company.

My experience has been that these criteria ("minimum investment amount" and "open to new investors?") can be plugged into a fund screener so you don't have to review each fund individually.

Mutual Fund Company's Sales Fees (if any)

Sales fees (i.e., front-end load, deferred loads, redemption fees) charged by mutual fund companies can adversely affect investment return and are not compatible with the risk management approaches we use.  Thus, I do not invest under any circumstances in any mutual funds with a load or a redemption fee, including a percent-based early redemption fee.  Any fund with any such fees is screened out immediately.

Redemption fees charged by fund companies (many are in effect for 90 days after purchase and are a calculated as a percent (e.g., 2%) of initial investment) conflict with my "buy and protect" risk management strategy to keep losses below one (1) percent. The larger my initial investment, the more money we could potentially lose if an investment needs to be terminated early for risk management purposes.

This is what sales fee information looks like on Morningstar (as of 3/24/2014) for corporate high yield bond fund AHBIX (enter "AHBIX" in quotes box and then go to the "expense" tab).  At the time of this article, this fund had no sales fees at all.  Before buying, I always double check for sales fees by looking directly at the fund prospectus on our on-line brokerage's or on the Morningstar website.

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AHBIX - Sales Fee Information as of 3/24/2014

In contrast (for example) at the time this article was written, the municipal high yield bond mutual fund (PRFHX), identified as a no-load fund under "fee level comparison group", still had a redemption fee (2%) if the fund was sold within 90 days of purchase.

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PRFHX - Sales and Redemption Fee Information as of 3/24/2014

So don't rely on the fact that the fund is identified as "no load" if you want to avoid all sales fees because it still may have a percent-based redemption fee charged by the fund company - this must be checked separtately.  Note also that this redemption fee is different than the fixed-cost short-term redemption fees charged by brokerages, which are discussed later in this article (note: I am generally OK with fixed-cost short-term redemption fees if they are relatively minimal (e.g., $50) and can be considered part of my transaction cost).

My experience has been that "sales fees" (or related term) is a factor (variable) that also can be plugged into a fund screener so you don't have to review each fund individually.  Again, before investing, we always double check the fund's prospectus to make sure there are no sales fees whatsoever charged by the fund company.

Mutual Fund Company's Expenses Other mutual fund company fees (expenses) include management, 12b-1, and administrative.  Together these add up to a funds operational expenses and are expressed in terms of a funds "net expense ratio" also called a management expense ratio (MER).

For corporate high yield bond ETFs (e.g., HYG), the net expense ratio is about 0.50.  The ETF expense ratios can be used as a reference point. In comparison, low net expense ratios for corporate high yield bond mutual funds are about in the range 0.70 to 0.85.

Below is an example of information on a relatively low-fee corporate high yield bond mutual fund (THYYX) from Morningstar under the "expense" tab for this fund:

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THYYX - Mutual Fund Expense Information as of 3/24/2014

For municipal high yield bond ETFs (e.g., HYD), the net expense ratio is about 0.35.  For comparison, low net expense ratios for municipal high yield bond mutual funds are around 0.60.  Below is an example of information on a low-fee municipal fund (ABHYX) from the Morningstar under the "expense" tab for this fund:

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ABHYX - Mutual Fund Expense Information as of 3/24/2014

In comparison to ETFs, which have lower net expense ratios, I like to keep in mind that mutual funds are professionally managed and do not simply track an index like many ETFs do. Theoretically at least, having a professional fund manager continuously reviewing a mutual fund's bond holdings and buying/selling when appropriate should provide a higher-level of risk management. However, a high turnover of bond holdings and associated capital gains/losses may have other implications for taxable accounts - please seek professional advice on this as needed.

When comparing high yield bond mutual funds to each other, my view is that higher net expense ratios are not a deal breaker like sales fees (loads, redemption fees) discussed in the previous section.  I do try and invest in low net expense ratio funds, but also realize for some funds this can also be balanced by relatively higher performance (yield and price appreciation) compared to lower net expense ratio funds.  

Brokerage Transaction Costs 
Brokerage transaction costs include transaction fees (if any) and any associated fixed-cost early redemption fees (not to be confused with percent-based early redemption fees charged by mutual fund companies discussed above). 
Generally one will pay more in transaction fees (aka: trade commissions) for a mutual fund than an ETF when buying through a brokerage. But I accept this fact because we would rather not invest in ETFs for reasons indicated in other articles, including but not limited to higher volatility.
[Note: If you don't have an account established with an on-line brokerage or want to move an account from one on-line brokerage to another, it may be possible to negotiate reduced trade commission rates for mutual funds. For example, when we moved some accounts from one on-line brokerage to another we were able to reduce mutual fund trades from $49.99 to 17.99.]

I most often buy no-load (NL), no transaction fee (NTF) mutual funds that also do not have a percent-based redemption fee charged by the mutual fund company (again, always confirm the absence of this type of redemption fee by digging deeper on an investment information providers website and/or looking at the fund prospectus itself).  However, these NL, NTF funds may have a fixed-cost redemption fee charged by the brokerage if you sell within a certain number of days (e.g., 90 days after purchase)

Here is an example for ABHYX, which is labelled "NL" and "NTF" on its mutual fund "profile" page on the TD Ameritrade website:

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ABHYX - Mutual Fund Profile  Information as of 3/24/2014

Then by digging a bit deeper and looking under "Fees and Management" tab for ABHYX it can be seen that the fund company charges no percent-based redemption fee either:

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ABHYX - Mutual Fund Fees Information as of 3/24/2014

As indicated above, even if the fund company charges no sales fees at all, as in the case for ABHYX above, most brokerages have fixed-cost early redemption fees when buying a NL, NTF fund. 

The fixed-cost redemption fees are currently about $50 if sold within 180 days at the brokerages we use.  Often, for NTF funds, this redemption fee is not immediately evident (except maybe in fine print) until you are in the process of placing an order.  Here is an excerpt from a portion of the TD Ameritrade webpage that appears when placing an order for ABHYX:

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ABHYX - Mutual Fund Order Information as of 3/25/2014

Compared to the percent-based early redemption fees some mutual fund companies charge (often 2% of initial investment), which I avoid entirely, the fixed-cost redemption fees charged by brokerages are relatively minimal, especially as the amount invested becomes larger.  See the following two simple examples for comparison:

  • For a NL, NTF fund with a fixed $50 early redemption fee charged by the brokerage (and no mutual fund company early redemption fees) consider $5,000 and $50,000 initial investments. If sold early, the $5000 investment will incur a 1.0% (50/5000) penalty and the 50,000 investment will incur a 0.1% (50/50,000) penalty from the brokerage. 
  • For a fund that assesses a 2.0% early redemption fee if sold early, the $5,000 investment would incur a $100 (0.02 x $5,000) penalty and the $50,000 investment would incur a $1000 (0.02 x $50,000) penalty, charged by the mutual fund company.

Obviously, on a 50,000 investment, losing $50 (0.1%) in fees is much better than losing $1000 (2.0%)

Since I typically have several transactions per year depending on market conditions, these fixed-cost early redemption fees charged by the brokerage are sometimes hard to avoid.  Since I usually buy NL, NTF funds (again with no percent-based redemption fees), these fixed-cost early redemption fees are just considered part of the transaction cost (worse case).  "Worse case" because when buying NL and NTF funds I am paying nothing at all in transaction costs when I can hold for over 180 days, and $50 in transaction costs when I cannot hold for over 180 days and are assessed the fixed $50 early redemption fee by the brokerage.

Dividend Yield
Yield is often reported in two ways, the trailing twelve month (TTM) yield and 30-day SEC yield. For an explanation and discussion of these two yields please refer to the following Morningstar article: "A Tale of Two Yield - Part I".

It is important to keep in mind that neither of these two ways of expressing past yields from a fund are ideal, and neither are predictive of future yields from a fund.
As with other criteria, dividend yield for various funds can be evaluated and compared using a mutual fund screener.  For individual funds, yield can be identified on a brokerage's website or at Morningstar on the top of the quote tab for that fund.  For example, below is an excerpt from the Morningstar quote page for corporate high yield bond fund NHINX:

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NHINX - Mutual Fund Yield Information as of 3/25/2014

It may be important to note here, based on relatively low yields at the time of this article (i.e., 5 to 6 percent TTM for corporate high yield bonds), potential capital gains/losses from share price changes are relatively much more substantial than returns from dividends alone. A monthly dividend for a corporate high yield bond fund can effectively be negated if the share price drops by only about 5 cents over that month.  This fact makes risk management and price performance using chart-based technical analysis an important strategy when long-term capital preservation and growth is a key objective. 

Relative Price Performance and Chart Patterns 

So after going through the above screening process, I am at a point where I (hopefully) have at least several funds that have passed the above criteria that I can add to my tracking portfolios.  I typically maintain several tracking portfolios for high yield bond funds, one each for corporate (U.S.), municipal (U.S.), and emerging market.

I can, on a periodic basis, further evaluate and compare relative price performance of the funds in each portfolio by overlaying the funds on the same time-series graph for different time periods using simple, readily available charting software available on your brokerage's website and elsewhere (e.g.,  Funds that continually have superior price performance may be favored over others for investment.

At the same time, I also want to identify the funds in each portfolio that have relatively clear and repeatable chart patterns versus those that do not. Ideally, and often is the case, the funds with superior price performance will also be those that have clear and repeatable chart patterns.  If not, it may be necessary to track and analyze some funds while investing in others.  

[Note:  In some circumstances, I track a fund that was screened out early (because of percent-based redemption fee, for example) but has a relatively clean and repeatable chart pattern and good relative price performance. Municipal high-yield bond fund PRFHX is an example. I only track PRFHX because it is a good indicator for municipal high yield bond funds.  I would not invest in it because it has a 2 percent early redemption fee.]

I will then track and invest in these funds when the time is right using strategies based on chart-based technical analysis. Examples of charts and analyses on various funds we track appear throughout this website.  

Not Investment Advice | Important Disclaimer: 
High Yield Bonds and High Yield Bond Funds (aka: Junk Bonds and Junk Bond Funds) are risky investments that can lose value. High Yield Bonds and High Yield Bond Funds may be inappropriate investments for you depending on your specific circumstances, which we cannot be aware of. The content in this article, including the identification and discussion of any specific security (e.g., high yield bond fund), is NOT meant to be and should NOT be used as investment advice. This article is for general information and educational purposes only. Please read the Disclaimers for in their entirety. The U.S. Securities and Exchange Commission website has guidance on selecting an investment adviser if you need one.

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