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The Bull Case
| May 23, 2012 | 08:21 AM EDT

For ETF investors, this means steering clear of the government-heavy broad-market vehicles like iShares Barclays Aggregate Bond and Vanguard Total Bond Market and drilling down to the spread sectors.

“We’re very constructive on corporate credit; the fundamentals look extremely positive,’’ says Chris Molumphy, chief investment officer of Franklin Templeton Fixed Income Group.

U.S. corporate bonds turned in a solid 8.1 percent performance in 2011, and the momentum has remained intact. Companies have increased profits through a sluggish recovery by cutting debt, boosting productivity and taking advantage of ultra-low interest rates to refinance at favorable terms. These actions have helped improve credit quality, one of the main drivers of price increases.

Improving fundamentals and a stabilizing economy should also benefit junk bonds. The current default rate of 1.7 percent for bonds rated below investment grade is low compared with the 4.2 percent long-term average. Junk-bond issuers should be in the clear for the next three years before the effects of refinancing at lower rates and extending maturities begin to wear off, says Mary Austin, portfolio manager of the Pax World High Yield Bond Fund.

“When GDP [growth] is 2 percent or lower, high yield has historically outperformed,’’ she adds.

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