Bonds are rated according to their risk of default by independent credit rating agencies such as Moody's, Standard & Poor's and Fitch. Those with lower ratings have higher risks associated with them that investors should consider. Due to increased risks, these bonds typically carry higher coupon rates. Issuers, such as consumers with less-than-perfect credit, must pay more for loans. While investing in lower-rated bonds carries more risk when buying these junk bonds, do not completely write them off. There are opportunities among lower-rated bonds that can still prove to begood investments; you just have to know what to look for when investing.
Key Takeaways
- High-yield, or "junk" bonds are those debt securities issued by companies with less certain prospects and a greater probability of default.
- These bonds are inherently more risky than bonds issued by more credit-worthy companies, but with greater risk also comes greater potential for return.
- Identifying junk bond opportunities can boost a portfolio's performance, and diversification through high-yield bond ETFs can cushion any one poor performer.
Junk Bond Opportunities
Identifying goodopportunities among junk bondscan be difficult for the average investor. For this reason, the best way to invest in lower-rated bonds is through a high-yield mutual fund, closed-end fund(CEF) or exchange-traded fund (ETF). Investing this way gives your portfolio better diversification across several issues of high-yield bonds. Also, holding shares of a high-yield fund gives you access to professional money management. These mutual fund managers have more knowledge and time to research each bond issue held within the portfolio than an average investor.
Furthermore, investing through a mutual fund, CEF or ETF allows for the use of leveraging techniques, bulk discounts and some bond issues that are only accessible to institutional investors like a fund.CEFsonly issue a specified number of shares, and then the portfolio trades in the secondary market. If you can find a CEF trading at a discount to its net asset value, or NAV, you stand to profit not only from the high income payments but also from some growth on your principal investment. A few notable high-yieldETFsare theSPDRBarclays High Yield Bond (JNK) andiSharesiBoxx$ High Yield Corporate Bond (HYG).If you are set on choosing individual high-yield bonds to purchase for your portfolio, recognize that the necessary due diligence on your part will increase. Consider first selecting issues from companies deemed "fallen angels," those companies that are historically reputable but have temporary financial problems.
Other Considerations
By choosing to invest in bonds from these companies, you are likely to find deep discounts and high yields but can rest assured that the chances of the company defaulting on the debt are not as likely as current ratings may reflect in the market. Peruse the company's financial statements and sentiment toward the company's stock. If the stock is still valuable, the bond issue is likely to be fine too.
Follow interest rate patterns and changes; you profit from owning high-yield bonds in a rising interest rate environment as prices increase as yields align with new issues at prevailing higher rates.
What The Experts Have to Say:
Advisor Insight
Donald P. Gould
Gould Asset Management, Claremont, CA
High yield bonds are not intrinsically good or bad investments. Generally, a high yield bond is defined as a bond with a credit rating below investment grade; for example, below S&P’s BBB. The bonds' higher yield is compensation for the greater risk associated with a lower credit rating.
High yield bond performance is more highly correlated with stock market performance than is the case with higher-quality bonds. When the economy weakens, profits tend to decline and so does the ability of high yield bond issuers (generally) to make interest and principal payments. This leads to declining prices on high yield bonds. Declining profits also tend to depress stock prices, so you can see how economic news, good or bad, could cause stocks and high yield bonds to move in the same direction.
FAQs
High-yield bonds generally face less interest-rate risk than their investment-grade counterparts—meaning that, all else equal, they suffer smaller price losses when interest rates rise. (Investors can compare interest-rate risk by looking at a bond or bond fund's duration.) But credit risk is higher.
What is the outlook for high-yield bonds in 2024? ›
Looking at the asset class's historical performance leads us to believe that high yield is poised to produce a positive return in 2024, albeit not as robust as that experienced in 2023. We believe that the economy is not rolling over and that a recession is likely to be at least six months away.
What are the risks of investing in high-yield bonds? ›
While high-yield bonds do offer the potential for more gains compared to investment-grade bonds, they also carry a number of risks, like default risk, higher volatility, interest rate risk, and liquidity risk.
What is the forecast for high-yield bonds? ›
The firm's 10- to 15-year forecast for high-yield bonds is 6.5% for 2024, down from 6.8% for 2023, and its forecast for emerging-markets sovereign bonds dropped to 6.8% from 7.1%.
What percentage of a portfolio should be in high-yield bonds? ›
Meketa Investment Group recommends that most diversified long-term pools consider allocating to high yield bonds, and if they do so, between five and ten percent of total assets in favorable markets, and maintaining a toehold investment even in adverse environments to permit rapid re-allocation should valuations shift.
Is now a good time to buy bonds in 2024? ›
As inflation finally seems to be coming under control, and growth is slowing as the global economy feels the full impact of higher interest rates, 2024 could be a compelling year for bonds.
Should you sell bonds when interest rates rise? ›
If bond yields rise, existing bonds lose value. The change in bond values only relates to a bond's price on the open market, meaning if the bond is sold before maturity, the seller will obtain a higher or lower price for the bond compared to its face value, depending on current interest rates.
Why not to invest in high yield bonds? ›
What are the risks? Compared to investment grade corporate and sovereign bonds, high yield bonds are more volatile with higher default risk among underlying issuers. In times of economic stress, defaults may spike, making the asset class more sensitive to the economic outlook than other sectors of the bond market.
What happens to high yield bonds in a recession? ›
The big deal with high-yield corporate bonds is that when a recession hits, the companies issuing these are the first to go. However, some companies that don't have an investment-grade rating on their bonds are recession-resistant because they boom at such times.
Why are bonds not a good investment? ›
Cons. Bonds are sensitive to interest rate changes. Bonds have an inverse relationship with the Fed's interest rate. When interest rates rise, bond prices fall.
When rates go up, bond prices typically go down, and when interest rates decline, bond prices typically rise. This is a fundamental principle of bond investing, which leaves investors exposed to interest rate risk—the risk that an investment's value will fluctuate due to changes in interest rates.
Is now the time to buy high yield bonds? ›
High-quality bond investments remain attractive. With yields on investment-grade-rated1 bonds still near 15-year highs,2 we believe investors should continue to consider intermediate- and longer-term bonds to lock in those high yields.
Should I invest in high yield? ›
Because the high yield sector generally has a low correlation to other sectors of the fixed income market along with less sensitivity to interest rate risk, an allocation to high yield bonds may provide portfolio diversification benefits.
How to invest in high-yield bonds? ›
You can invest directly in high-yield corporate bonds by buying them from broker-dealers. Alternatively, you can invest in these high-yield bonds indirectly by buying shares in mutual funds or exchange-traded funds (etFs) with a high-yield bond focus.
What is the average maturity of a high yield bond? ›
Because these companies are riskier, they're generally not able to borrow money for as long a period of time as you'd see in the investment grade corporate bond market. So the average maturity of the high yield market is around 6 years, which is shorter than that of the investment grade bond market.
What is the global bond outlook for 2024? ›
Total OECD government bond debt is projected to increase to USD 56 trillion in 2024, an increase of USD 30 trillion compared to 2008. At the end of 2023, global corporate bond debt reached USD 34 trillion and over 60 per cent of the increase since 2008 came from non-financial corporations.
What is the credit market outlook for 2024? ›
Looking at 2024, there is room for more optimism in the credit space, with expectations for strong total returns and continued demand from investors seeking high-quality duration and longer-maturity investment solutions, supported by anticipated interest rate cuts by major central banks.
What is the long term bond yield forecast? ›
The United States 20 Years Government Bond Yield is expected to be 5.163% by the end of September 2024.
What is the stock market outlook for 2024? ›
The US stock market enjoyed a strong first quarter in 2024, advancing 10%. But inflation was stickier than some expected. In fact, the March CPI number that came out this morning was hotter than expected, too. And that's leading many to question when the Federal Reserve will begin cutting interest rates.
